UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

For the fiscal year ended December 31, 2016

Or

For the transition period from             to            

Commission File No. 001-36814

 

Entellus Medical, Inc.

(Exact name of registrant as specified in its charter)

 

 

(763) 463-1595

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ☒ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of June 30, 2016, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $137.3 million based on the closing price of the registrant’s common stock of $18.27 as reported on the Nasdaq Global Market on that date. Shares of common stock held by each executive officer, director, and holder of more than 10% of the registrant’s common stock have been excluded from this calculation as such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of February 15, 2017, there were 21,877,702 shares of the registrant’s common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s proxy statement for the 2017 Annual Meeting of Stockholders expected to be held on June 13, 2017 are incorporated by reference into Part III of this report.

 

 

 

 

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ENTELLUS MEDICAL, INC.

ANNUAL REPORT ON FORM 10-K

YEAR ENDED DECEMBER 31, 2016

TABLE OF CONTENTS

 

 

As used in this report, the terms “we,” “us,” “our,” “Entellus Medical,” “Entellus” and the “Company” mean Entellus Medical, Inc. and our consolidated wholly-owned subsidiary, unless the context indicates another meaning.

 

 

 

 

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PART I

Cautionary Note Regarding Forward-Looking Statements

Except for historical information, the matters discussed in or incorporated by reference into this Annual Report on Form 10-K are forward looking statements that involve risks, uncertainties and assumptions that, if they never materialize or if they prove incorrect, could cause our actual results to differ materially from those expressed or implied by such forward-looking statements. We make such forward-looking statements under the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Actual future results may vary materially from those projected, anticipated or indicated in any forward-looking statements as a result of various factors, including those set forth in Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors.” Readers should also carefully review the risk factors described in the other documents that we file from time to time with the Securities and Exchange Commission, or the SEC. In this Annual Report on Form 10-K, the words “anticipates,” “believes,” “expects,” “intends,” “future,” “could,” “estimates,” “plans,” “would,” “should,” “potential,” “continues” and similar words or expressions (as well as other words or expressions referencing future events, conditions or circumstances) identify forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. The forward-looking statements contained in this Annual Report on Form 10-K include, but are not limited to, statements related to:

Forward-looking statements are based on management’s current expectations, estimates, forecasts and projections about our business and the industry in which we operate, and management’s beliefs and assumptions are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this Annual Report on Form 10-K may turn out to be inaccurate. Furthermore, if the forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. Factors that may cause actual results to differ materially from current expectations include, among other things, those described in the section entitled “Risk Factors” and elsewhere in this Annual Report. Readers are urged to consider these factors carefully in evaluating these forward-looking statements. These forward-looking statements speak only as of the date of filing of this Annual Report on Form 10-K. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

 

 

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Overview

We are a medical technology company focused on delivering superior patient and physician experiences through products designed for the minimally invasive treatment of chronic and recurrent sinusitis in both adult and pediatric patients. Our platform of products provides effective and easy-to-use solutions designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. Our three core product lines, XprESS Multi-Sinus Dilation Systems, MiniFESS Surgical Instruments, and FocESS Imaging & Navigation, are designed to enable ear, nose and throat, or ENT, physicians to conveniently and comfortably perform a broad range of procedures in the ENT physician office and to simplify operating room-based treatment. When used as a stand-alone therapy in the physician’s office, our XprESS balloon sinus dilation products are the only devices proven in a sufficiently powered prospective, multicenter, randomized, controlled trial to be as effective as functional endoscopic sinus surgery, or FESS, the primary surgical treatment for chronic and recurrent sinusitis. Patients treated with our products in this trial in the ENT physician office also experienced faster recovery, less bleeding at discharge, less use of prescription pain medication and fewer post-procedure debridements than patients receiving FESS. We estimate that physicians have treated over 150,000 patients with our XprESS products since the launch of the first XprESS product in February 2010.

Our addressable patient population consists of a portion of patients who undergo FESS, as well as patients who fail medical management but do not undergo sinus surgery. We estimate the annual total addressable market for our products in the United States is approximately 690,000 patients, which, based on our estimate of the average revenue per procedure in the balloon sinus dilation market, represents an annual market opportunity of approximately $1.0 billion.

We believe our minimally invasive balloon sinus dilation devices and additional sinus surgery products sold by us have facilitated a shift towards office-based treatment of chronic and recurrent sinusitis patients who are candidates for sinus surgery in the operating room. We believe this shift has been facilitated by our technology and clinical data, as well as procedure economics that are favorable to the healthcare system, patient and provider. Our XprESS family of products is used to treat patients with inflammation of the frontal, ethmoid, sphenoid and maxillary sinuses and is specifically designed for ease-of-use in the ENT physician office setting. Our XprESS family of products includes our XprESS Pro device, our XprESS LoProfile device and our XprESS Ultra device. We derive a significant portion of our revenue from our XprESS family of products. Our research and development efforts are focused primarily on enhancing our XprESS family of products and broadening their indications for use, as well as developing new, related products.

Product development and innovation are an important part of our strategy. In November 2015, we received clearance from the U.S. Food and Drug Administration, or the FDA, for a pediatric indication for our XprESS Multi-Sinus Dilation System, thereby expanding the patient population to include treatment of maxillary sinuses in patients two years and older, and treatment of the frontal and sphenoid sinuses in patients 12 years and older. We believe we are the only company to have received FDA clearance for balloon sinus dilation to treat the frontal and sphenoid sinuses in adolescents.

In 2016, we acquired and entered into an exclusive license for XeroGel nasal packing material, and we now manufacture and sell XeroGel product to hospitals, physician offices and ambulatory surgery centers, or ASCs. Prior to this transaction, we were the exclusive distributor of XeroGel nasal packing material in the United States. Also in 2016, we introduced several new products, including sterilization trays, Fiagon accessories, and, in the third quarter, our Cyclone Sinonasal Suction and Irrigation System. In the fourth quarter of 2016, we initiated limited launches of our Entellus Medical Shaver System and our FocESS Wireless High Definition (HD) Camera System and completed full launches of both products in the first quarter of 2017.

We have a diverse customer base of ENT physicians, hospitals and ASCs, with no single customer accounting for more than 5% of our revenue during the year ended December 31, 2016. Our customers are generally reimbursed by governmental and private health insurers for procedures using our products pursuant to reimbursement codes specific to the procedure and the setting. In November 2016, Medicare issued a final rule on the Hospital Outpatient Prospective Payment System, or OPPS, for 2017 which includes a reduction of payments for certain outpatient procedures performed in the hospital when FESS is performed on more than two sinuses. The result is to bundle payments for multi-sinus surgery regardless of the number of sinuses being treated. On average, we expect most hospitals will experience a reduction in Centers for Medicare and Medicaid Services, or CMS, reimbursement because the average number of sinuses being treated is more than two. As of December 2016, third-party payor insurance coverage for stand-alone balloon sinus dilation procedures is available for an estimated 230 million persons in the United States, which represents 80% of covered lives.

In December 2016, the National Institute for Health and Care Excellence, or NICE, provided positive guidance for use of our XprESS Multi-Sinus Dilation System in the United Kingdom, recommending it for use in patients with uncomplicated chronic sinusitis who do not have severe nasal polyposis. In these patients, NICE has asserted that, in comparison with FESS, our XprESS Multi-Sinus Dilation System works as well, is associated with faster recovery times and can more often be performed under local anesthesia. NICE provides evidence-based guidance and advice to the National Health Service in England and other public health and social care services to improve health and social care. The NICE guidance is specific to the XprESS Multi-Sinus Dilation System and

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does not extend to any other balloon sinus dilation technology. NICE estimates that, by adopting our technology, the National Health Service in England may save up to £7.4 million per year by 2020.

We currently sell our products through a direct sales force in the United States and United Kingdom and through international distributors in over 10 countries. As of December 31, 2016, we employed a total of 90 full quota-carrying representatives. We expect to continue to expand our sales force and staffing to further penetrate the sinusitis market. We also intend to continue to increase our presence outside the United States through expansion of our United Kingdom sales force and the addition of distributors. Financial information about our revenues from and assets located in foreign countries is included in Note N of our consolidated financial statements.

Overview of Sinusitis and the Market

Chronic sinusitis is a common medical condition that, according to estimates from the Centers for Disease Control and Prevention, or CDC, impacts approximately 12% of the adult population aged 18 and over in the United States, or approximately 29 million people based on 2013 U.S. Census Bureau data, making it more prevalent than asthma or heart disease. In addition to the adult population, based on research published in The Laryngoscope in 2006, we estimate that approximately 6 million Americans under the age of 18 suffer from chronic sinusitis bringing the total U.S. prevalence to approximately 35 million.

We estimate the annual total addressable market for our products in the United States is approximately 690,000 patients, which, based on our estimate of the average revenue per procedure in the balloon sinus dilation market, represents an annual market opportunity of approximately $1.0 billion. Our addressable patient population consists of a portion of patients who undergo FESS, as well as patients who fail medical management but do not undergo sinus surgery. We believe that out of the adult patients aged 18 and over in the United States who are expected to undergo FESS procedures in 2016, approximately 55% are well-suited for office-based balloon treatment because they present with uncomplicated sinusitis and do not require a septoplasty procedure to correct a severely deviated septum and approximately 30% are well-suited for treatment with a hybrid balloon sinus dilation procedure in the operating room along with a FESS procedure due to the location and nature of their sinusitis. In addition, we believe that approximately 85% of the patients who fail medical management but do not undergo FESS represent a significant market opportunity, as these patients currently avoid sinus surgery, seek a non-surgical alternative procedure to FESS after fewer episodes of failed medical management, or are increasingly referred by primary care physicians to ENT physicians for their chronic sinusitis. We estimate this current market opportunity to be approximately 160,000 patients annually in the United States, and believe that patient population will increase and be amenable to balloon sinus dilation as the number of physicians trained on procedures and clinical evidence supporting the benefits of office-based balloon sinus dilation continues to grow.

Sinuses are air-filled pockets within the bones of the face and skull. The four types of sinuses are frontal, ethmoid, sphenoid and maxillary. One of each type of sinus lies on each side of the face.

The sinuses are lined with soft, moist tissue, or mucosa, that is covered with a layer of mucus. Mucus moistens the nasal lining and protects the body from inhaled impurities such as dust, pollutants and bacteria. Each of the maxillary, sphenoid and frontal sinuses has a corresponding ostium, or opening, through which mucus drains. The ethmoid sinuses are a series of cells with multiple, often interconnected openings and drainage pathways. The surface tissues of the sinuses are covered with millions of cilia, which are small, hair-like structures that act in coordination to sweep the mucus through the ostium of each sinus cavity to the back of the throat. The drainage of mucus is a normal process that keeps the sinuses healthy.

Sinusitis is inflammation of the sinus cavities that may be caused by infections, allergies or environmental factors, as well as structural issues such as blockage of an ostium. If one or more sinus drainage pathways becomes blocked, normal mucus drainage is prevented and damage to ciliary function may occur. There are three categories of sinusitis: acute, recurrent acute and chronic. Acute sinusitis is transient in nature and lasts less than four weeks. Recurrent acute sinusitis is a type of chronic sinusitis that involves four or more episodes of acute sinusitis over a 12-month period. Chronic sinusitis is more severe and lasts 12 weeks or longer. We refer to

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recurrent acute sinusitis and chronic sinusitis together as chronic sinusitis. The symptoms of sinusitis include facial pain, pressure, nasal congestion, headaches, fatigue and loss of smell. When persistent, these symptoms can severely impact a patient’s day-to-day well-being, resulting in frequent doctor visits and can lead to reduced sleep function, chronic fatigue and depression. The condition significantly reduces work productivity, increases absenteeism and impairs daily activities.

Chronic sinusitis is associated with substantial healthcare utilization and expenditure and ranks as one of the ten costliest physical health conditions, contributing to an estimated $8.6 billion in direct healthcare costs in the United States. The latest CDC ambulatory medical surveys estimated that chronic sinusitis resulted in 12.3 million physician visits annually in the United States in each of 2009 and 2010, of which an estimated 8.1 million were to primary care physicians, 2.8 million were to ENT physicians, and the remainder were to hospital outpatient facilities and emergency rooms. We estimate that the 2.8 million annual patient visits to ENT physicians in the United States represent approximately 1.23 million distinct patients seen annually by ENT physicians. Primary care and ENT physicians rely on medical management for first-line therapy to treat chronic sinusitis. In cases where patients remain symptomatic despite multiple rounds of medical management, a physician may recommend FESS or balloon sinus dilation combined with FESS, or in cases of uncomplicated chronic sinusitis, may recommend stand-alone balloon sinus dilation. Uncomplicated chronic sinusitis is sinus disease that does not include fungus, extensive polyps, or inflammation and infection of the bones below the sinus mucosa. We estimate that, of the 1.23 million adult patients aged 18 and over in the United States with chronic sinusitis who were expected to be seen by ENT physicians in 2015, 552,000 underwent FESS, while 493,000 had symptoms relieved by medical management and 188,000 failed medical management but elected not to undergo FESS.

Current Treatments for Sinusitis and their Limitations

The treatment of sinusitis is progressive in nature and involves therapies that attempt to achieve the most effective solution in the least invasive manner. Treatment typically begins with medical management, and if this is unsuccessful, an ENT physician may perform FESS or a balloon sinus dilation procedure to treat both symptoms and obstruction of the sinus drainage pathways.

Medical Management

Sinusitis patients often present with a sinus infection and nasal congestion. Therefore, first-line therapy typically involves the use of prescription medications, such as antibiotics and decongestants. If the condition persists, physicians may prescribe more aggressive medical management, including additional antibiotics, oral steroids or intra-nasal steroid sprays to reduce inflammation, or saline irrigations to loosen mucus. To facilitate increased delivery of steroids to inflamed sinus tissue, reduce symptoms and reduce recurrence of polyps, physicians may also prescribe off-label use of steroids added to nasal irrigation solutions.

While medical management can be effective, its effect is often temporary, and it is unable to address the underlying anatomical issues such as chronically narrowed or obstructed sinus drainage pathways that may be contributing to the condition. Even where medical management is effective, prolonged medication use can give rise to undesirable side effects. For example, frequent use of antibiotics can lead to the development of antibiotic resistance and repeated use of decongestant sprays can cause nasal congestion rebound, or an increase in nasal congestion after stoppage of use. Similarly, prolonged use of oral steroids can produce potentially serious side effects such as aggressive behavior, sleeplessness, glaucoma, bone loss, weight gain, high blood pressure and psychosis. Medical management also represents an ongoing expense to patients and payors. Based upon published studies, we estimate that approximately 60% of chronic sinusitis patients who are seen by ENT physicians and receive medical management remain symptomatic.

Sinus Surgery

In cases where patients diagnosed with sinusitis are unresponsive to multiple rounds of medical management, an ENT physician may recommend surgical treatment. The primary surgical alternative is FESS, which attempts to open the sinus drainage pathways such as the ostia while attempting to preserve as much bone and sinus mucosa as possible. FESS is typically performed under general anesthesia in an operating room during a procedure that typically takes approximately two hours. During FESS, an ENT physician inserts an endoscope into the nasal cavity to view a patient’s anatomy. The physician typically uses rigid steel instruments and powered cutting tools to remove inflamed sinus tissue and underlying bone to create a larger passage through the nasal anatomy to the infected sinuses, where the physician then removes additional tissue and bone to open the sinus ostia. Surgeons may also perform additional surgery on a deviated nasal septum or enlarged turbinate, a bulbous structure in the nose that warms and humidifies air, in the nose to treat nasal obstruction or simply to gain surgical access to the sinuses. At the conclusion of the procedure, patients often have their nasal cavity packed with a material that acts as a spacer to prevent surgical adhesions and control bleeding. Patients typically require one or more follow-up debridement treatments in which the physician may remove more tissue, crusting, scabs or scar tissue at the area of surgery in order to keep the sinus drainage pathway open and promote proper healing.

While FESS is often effective at treating chronic sinusitis, FESS results in irreversible changes to the anatomy and significant postoperative pain, discomfort and recovery time. In addition, postoperative debridement is unpleasant for the patient and costly to the healthcare system. Although FESS is the standard of care, approximately 7% to 12% of FESS patients require revision surgery, often as a result of ongoing inflammation and scarring associated with the procedure. Within the first year following a FESS procedure,

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approximately 64% of patients experience recurrent symptoms. In addition, given the use of surgical tools in close proximity to the brain, eyes and other critical anatomy, the potential for significant complications is a concern of physicians and patients alike. The risks of FESS, particularly in the frontal sinuses, cause some ENT physicians to avoid performing surgery in the frontal sinus drainage pathway. Major complications, such as cerebral spinal fluid leaks, swelling of the eye or blindness, occur in approximately 1% of FESS procedures. We believe that patient concerns about undergoing sinus surgery, postoperative discomfort, multiple days of recovery time and potential complications can make patients hesitant to undergo FESS. As an example, in our REMODEL trial, 14 of 75 patients randomized to the FESS arm of the trial refused surgical treatment and withdrew from the study. Eight of these patients indicated they were withdrawing because they did not want to undergo surgical treatment, one indicated withdrawal because the person’s primary physician recommended not undergoing FESS, three indicated they were withdrawing due to other non-sinus medical conditions or a lack of time available for follow-up, and two were found to have exclusion criteria upon further review. Only two of 76 patients randomized to balloon sinus dilation indicated they were withdrawing before treatment because of not wanting the balloon procedure.

Balloon Sinus Dilation

Balloon sinus dilation was developed to provide patients with a minimally invasive, long lasting treatment alternative that was more effective than medical management, at least as safe and efficacious as FESS and that preserves sinus mucosa and future treatment options. By employing balloon sinus dilation as a non-surgical method to open blocked sinus pathways, balloon sinus dilation spares mucosa while increasing ventilation and mucus drainage, which preserves the natural function of the cilia and important natural anatomical structures, such as the uncinate process, which is a tissue bridge that prevents inhaled dust and bacteria from easily entering maxillary sinus ostia.

Balloon sinus dilation can be performed as a stand-alone procedure using local anesthesia in the ENT physician office, typically in approximately one hour. In a typical office-based balloon sinus dilation procedure, the physician uses topical anesthetics followed by an injection to numb the patient’s sinus lining. Once a patient’s nasal passages and ostia are numb, the physician inserts a balloon sinus dilation product into the nose using endoscopic visualization, and guides the balloon device into a narrowed sinus drainage pathway. Some balloon sinus dilation products use a guide catheter and guidewire to direct the balloon into a sinus drainage pathway. In conjunction with placing the balloon into the ostium, the physician confirms the balloon device has correctly accessed the sinus, often using methods such as direct endoscopic visualization or transcutaneous visualization of light emanating from the tip of a balloon device or guidewire. The balloon is then inflated to a high pressure, resulting in fracture and remodeling of the bones underlying the sinus mucosa. For patients with multiple obstructed sinus drainage pathways, the physician may repeat the process of placement, confirmation and inflation in each affected sinus. Balloon sinus dilation can also be used with FESS performed under general anesthesia in the operating room.

ENT physicians are increasingly treating more complicated sinusitis patients in the office with a procedure known as mini-FESS. This procedure combines office-based balloon sinus dilation of the obstructed sinus drainage pathways with limited excision of adjacent tissue, including polyp removal, removal of diseased ethmoid air cells, or reduction of enlarged turbinates. We expect the adoption of mini-FESS procedures will broaden the population of patients treatable with office-based balloon sinus dilation products, and will also facilitate use of our MiniFESS products, Fiagon Image Guidance System, or Fiagon IGS, Entellus Medical Shaver System and FocESS products. We believe this trend will be enhanced as ENT physicians prescribe on-label as well as off-label use of steroids in nasal irrigations to reduce polyp recurrence and promote healing following excision of sinus tissue.

Despite the advantages of a minimally invasive balloon sinus dilation procedure, we believe its adoption has been limited by a number of historical factors that include:

In addition, a limitation of balloon sinus dilation is that it does not remove irreversibly diseased sinus mucosa, which may be present in patients with sinusitis complicated by fungus, extensive polyps and infection of the bones below the sinus mucosa.

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Our Competitive Strengths

We are focused on the treatment of sinusitis, one of the most common medical conditions in the United States resulting in patient visits to physicians. We have a broad product line of minimally invasive technologies for diagnosing and treating sinusitis patients after failed medical management. Our platform of products provides effective and easy-to-use solutions and is designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. Our products are intended to further transition the treatment of uncomplicated sinusitis from the operating room to the physician office setting. We believe our following competitive strengths will help drive further adoption of our products:

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XprESS device accessing the maxillary sinus with 135° bend angle

and trans-illumination of the uncinate process

Our Products

We have a broad product line of minimally invasive technologies for diagnosing and treating sinusitis patients after failed medical management. Our platform of products provides effective and easy-to-use solutions and is designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. Our products are intended to further transition the treatment of uncomplicated sinusitis from the operating room to the physician office setting. Our XprESS Multi-Sinus Dilation family of devices and related tools have been specifically designed to enable easy access to the sinus cavities under endoscopic visualization, and provide confirmation of sinus location and device placement using multiple methods. These products facilitate the access and dilation of blocked sinus ostia and pathways in order to reestablish proper mucus transport and drainage with retained ciliary function. When used as a stand-alone therapy in the physician’s office, our XprESS balloon sinus dilation products are the only devices proven in a sufficiently powered prospective, multicenter, randomized, controlled trial to be as effective as FESS, the primary surgical treatment for chronic and recurrent sinusitis. Patients treated with our products in this trial in the ENT physician office also experienced faster recovery, less bleeding at discharge, less use of prescription pain medication and fewer post-procedure debridements than patients receiving FESS. Our array of other products are aimed at assisting in the evaluation and diagnosis of sinusitis and tools to facilitate the treatment of sinusitis and related conditions, and include our Light Fibers, MiniFESS tools and surgical instruments, and FocESS Imaging & Navigation tools, including FocESS Sinuscopes and our recently launched Cyclone Sinonasal Suction and Irrigation System, Entellus Medical Shaver System and our FocESS Wireless High Definition (HD) Camera System. Finally, the Fiagon IGS that we distribute is suited for allowing treatment of more complex cases in the physician’s office, and our XeroGel nasal packing material aids in the post-operative healing process.

XprESS Multi-Sinus Dilation Product Family

Our XprESS Multi-Sinus Dilation family of products consists of our XprESS Pro device, our XprESS LoProfile device and our XprESS Ultra device. The XprESS LoProfile device and the XprESS Ultra device are always sold with our LED Light Fiber. All of these disposable devices open an obstructed or narrowed drainage pathway of a sinus cavity by means of trans-nasal balloon sinus dilation. These devices combine multiple functions in a hand-held, single, easy-to-use, cost-effective and minimally invasive device designed for efficient balloon sinus dilation procedures in the physician office or operating room. Our XprESS devices combine the features of balloon sinus dilation, suction, irrigation and light confirmation into a single-use device shaped to feel like a sinus seeker, a tool used regularly by ENT physicians to probe for sinus openings and drainage pathways. Our XprESS Pro device is compatible with the Fiagon IGS and enables tracking of the tip of the XprESS device allowing for additional confirmation of device placement.

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Our XprESS devices include an ergonomic handle attached to a hollow metal shaft with a malleable tip that can be quickly shaped with our disposable bending tool and easily steered into diseased frontal, sphenoid and maxillary sinuses without requiring a guidewire or purchase of another component. Along the shaft of the tip are marks at 1.0 and 2.0 centimeters to denote depth of insertion into the sinus cavities. A balloon is attached to a movable shaft that allows the balloon to be advanced and retracted along the metal shaft. This enables the balloon to be kept out of the way while the device is being placed into a sinus opening, allowing the ENT physician to better visualize and enter the diseased sinus drainage pathway. The handle contains a one-finger balloon slide mechanism that is used to position the balloon within the sinus ostia and an integrated finger suction vent that allows the ENT physician to control active suction in order to maintain good endoscopic visualization throughout the procedure. The proximal end of the handle contains two ports that connect to the balloon inflation lumen and the suction/irrigation lumen of the metal shaft. The port used for suction and irrigation tubing also can accommodate a connection of a light fiber for trans-illumination. The port for balloon inflation connects to a one-handed inflation syringe used to inflate the balloon to a controlled pressure of 12 atmospheres, or approximately 175 pounds per square inch.

Our XprESS Ultra device is our fourth generation balloon sinus dilation device. In addition to the features of our XprESS Pro and LoProfile devices, this device offers the lowest profile re-shapeable atraumatic ball tip balloon device in the industry. The tip of this device measures 1.5 millimeters, compared to 2.0 millimeters for our XprESS Pro and 1.75 millimeters for our XprESS LoProfile devices, allowing for better access to tight spaces within the sinus cavities.

LED Light Fiber and Light Fiber

The LED Light Fiber is a single-use tool that provides real-time high intensity red trans-illumination of the sinus cavity with its own battery power, eliminating the need for extra light sources, cables and adapters. This sinus confirmation tool consists of a flexible illumination fiber that emits light from the distal tip. The instrument snaps easily onto the proximal end of the XprESS device. A reduced diameter LED light fiber was developed and is currently packaged and sold with our XprESS Ultra and LoProfile products.

Our Light Fiber is a single-use tool that also provides real-time trans-illumination of the sinus cavity. The fiber is designed to be loaded into the XprESS device and can connect to various different cables and light sources. When the light fiber is connected to the XprESS device, it allows for suction or irrigation to be performed through that XprESS device.

XprESS multi-sinus dilation device with LED Light Fiber

FocESS Sinuscopes and FocESS Wireless HD Camera

Our FocESS Sinuscopes provide ENT physicians with an easy-to-use solution for endoscopic visualization during a sinus procedure. The scopes are 3.0 millimeters in diameter, which we believe makes them suited for use in tight and inflamed nasal anatomy. These high definition scopes come in three viewing angles; zero-degree, 30-degree and 45-degree to enable physicians’ unique views during sinus procedures.

Our FocESS Wireless HD Camera, which was sold to a limited number of customers in the fourth quarter of 2016 and released to the full market in the first quarter of 2017, provides high quality HD images on which physicians can rely without the hassle of additional cords and light sources. The combination of easy to integrate wireless technology without compromising on image quality makes the wireless camera unique in the ENT space.

MiniFESS Diagnostic Tools

Our MiniFESS tools are designed to provide ENT physicians with an easy way to confirm sinus location and XprESS device placement. The intent of these tools is to enable users to screen symptomatic patients for in-office balloon sinus dilation and to more

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easily and efficiently perform balloon sinus dilation procedures in the physician office and operating room. In addition, ENT physicians may use other competing devices to confirm sinus location and placement of XprESS devices.

Our diagnostic MiniFESS tools comprise our Light Seeker, Maxillary Seeker and Sphenoid Seeker/Freer. The Light Seeker is a tool with optical fibers embedded into the device intended to allow ENT physicians to access the frontal sinus and trans-illuminate the sinus cavity and forehead to confirm correct entry into the frontal sinus. The Light Seeker is used to confirm non-surgical access to the frontal sinus prior to opening our XprESS balloon kit. The Maxillary Seeker is a tool designed to allow users to quickly find the correct angle to access the natural maxillary ostia. The Sphenoid Seeker/Freer is a two-in-one tool that is designed to enable ENT physicians to navigate easier access to the sphenoid ostium and to manipulate the middle turbinate. These stainless steel tools are reusable and can be used prior to balloon sinus dilation or as general sinus surgery tools.

MiniFESS tools and XeroGel Nasal Packing Material

MiniFESS Surgical Instruments

Our MiniFESS family of surgical instruments includes eight devices designed to enable physicians to perform several traditional surgical procedures with ease and confidence. These devices include a turbinate forceps, two Blakesley thru-cutters, a 2.5 millimeter Takahashi forceps, a sickle knife and Blakesley forceps in zero-degree, 45-degree and 90-degree orientations, respectively. Each device is designed to be used in specific sinus procedures, which enables them to be utilized easily in the office setting on appropriate patients. In addition, our Turbinate forceps product enables physicians to create greater space in tight anatomy through the controlled and precise compression of an enlarged middle turbinate, which we believe can make sinus procedures easier for physicians to perform.

Our MiniFESS family’s Shaver System, released to a limited market in the fourth quarter of 2016 and to the full market in the first quarter of 2017, offers advanced technology in a compact size and is designed to be easy to use and provide high performance and reliability. With a combination of both disposable and reusable blades, we believe our shaver system offers physicians the flexibility they need to perform complex office procedures in a cost-efficient manner.

Our Cyclone Sinonasal Suction/Irrigation System is designed to provide simultaneous suction and irrigation for easy, comfortable saline lavage. In a recent survey over 40% of physicians say they regularly irrigate their sinusitis patients. Irrigation is a common practice but one that physicians may avoid due to patient discomfort. By simultaneously irrigating and suctioning the related effluent, our Cyclone Sinonasal Suction/Irrigation System is intended to minimize patient discomfort. This product was released to a limited market in the third quarter of 2016 and to the full market in the fourth quarter of 2016.

Fiagon Image Guidance System

The Fiagon IGS consists of a navigation unit, navigation sensor, software instruments and a patient localizer. The system is designed to be integrated into any endoscopy tower. We believe the easy-to-use interface, compact size and flexibility and ability of the Fiagon system to track tools from multiple manufacturers are advantages over traditional image guidance systems that require much larger physical footprints. Further, the Fiagon IGS has the capability to track our XprESS Pro device, which should provide physicians an added layer of confidence in device placement when desired. We believe the Fiagon IGS will help in the adoption of our products in treating more complex anatomical structures. In addition, the Fiagon IGS offers several additional disposable products including trackable suction and sinus-seeker like devices.

We are the exclusive distributor of the Fiagon IGS and related ancillary products to ENT physicians in physician offices, clinics and surgery centers, located in the United States, certain U.S. territories and Canada, subject to certain exceptions for third parties that distributed the Fiagon products, at the time we entered into the original five-year distribution agreement in August 2015. In June 2016, we expanded our agreement with Fiagon to include sales to hospital customers, including the sale of Fiagon’s Premium Navigation System allowing more advanced ENT and cranio-maxillofacial applications. We are also the exclusive distributor of Fiagon GuideWires attached to or sold with our balloon products to hospitals in the United States, certain U.S. territories and Canada. Under

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the terms of our distribution agreement, Fiagon has agreed not to collaborate with or support our competitors or any company intending to develop or commercialize products that are competitive with the Fiagon products we distribute or our balloon products in the United States, certain U.S. territories and Canada during the term of the agreement.

XeroGel Nasal Packing Material

Our XeroGel Nasal Packing Material is indicated for use in patients undergoing nasal or sinus surgery as a space-occupying packing to separate tissue or structures compromised by surgical trauma, prevent adhesions between mucosal surfaces, help control bleeding following surgery or trauma, and act as an aid in the natural healing process. XeroGel nasal packing material is also indicated for use to treat epistaxis, or nasal bleeding. XeroGel nasal packing material is a dissolvable co-polymer that contains chitosan, a naturally occurring element from chitin, or the exoskeleton of crustaceans. The co-polymer absorbs fluids, swells to conform to the treatment site and dissolves gradually, typically by the first postoperative visit.

Other Products

In addition to our internal product development efforts, we may leverage our direct U.S. sales force by licensing or acquiring other products that can be used by ENT physicians for the treatment of sinusitis and related diseases.

Clinical Results and Studies

Overview

We have developed a significant body of clinical data supporting the safety and effectiveness of our balloon sinus dilation products. We have sponsored one meta-analysis and eight clinical studies in which a total of 696 patients were treated with our products and followed to assess safety, and 538 patients were followed for an extended period of six to 24 months to assess long-term efficacy. Over 50 different clinical investigators participated in these clinical studies. Our clinical evidence includes the only published meta-analysis of patient-level data for stand-alone balloon dilation and the only published randomized trial with sufficient statistical power to demonstrate advantages of a nonsurgical treatment compared to traditional FESS for the treatment of chronic sinusitis. While we are aware of a limited number of studies comparing balloon dilation to FESS, these studies were small single-center studies that were under-powered, meaning their sample sizes were too small to prove their endpoints with sufficient statistical power. In contrast, the sample size for the REMODEL trial was calculated with sufficient statistical power (90%) at a one-sided alpha level of 0.025 to prove the two primary endpoints and hypotheses. The minimum required sample size was 72 patients (36 in each arm) and the trial exceed this requirement, with 130 patients completing 12-month follow-up. Our REMODEL prospective, multicenter, randomized, controlled trial demonstrated that when our balloon sinus dilation products were used as a stand-alone therapy performed in the ENT physician office, patients experienced better recovery outcomes and similar efficacy to FESS. Throughout all our clinical studies, symptom reduction was shown in a broad set of clearly defined patient groups, including those presenting with chronic sinusitis, mild to moderate septal deviations, multi-sinus disease including disease in all eight sinuses or sinusitis present in any combination of the sinuses, and accessory ostia, which are multiple drainage pathways from the maxillary sinus. We also completed two additional studies in which our products were studied in cadaver specimens. The first cadaver study demonstrated effective and accurate trans-nasal entrance through the maxillary ostia with our XprESS device. The second cadaver study demonstrated that access to frontal sinuses using our XprESS device with trans-illumination is as effective as placement of a probe with a CT image guidance system. Finally, we are currently conducting a clinical study to treat Eustachian tube dysfunction with our XprESS device. Outcomes data and information on recent key studies is described below.

Our clinical study data showed clinically meaningful and persistent levels of symptom reduction at one, three, six, 12 and 24 months. A study published in 2010 demonstrated that symptom improvements measured with QOL surveys after treatment with FESS do not appear to change between six and 20 months and recommended that clinical trial designs incorporating QOL outcomes following FESS should consider the six-month time frame as an appropriate long-term primary endpoint. Therefore, we believe that six-month follow-up is sufficient to assess long-term outcomes of our products. All but two of our eight clinical studies followed patients for at least 12 months.

Meta-analysis of Stand-alone Balloon Sinus Dilation Studies

A meta-analysis of stand-alone balloon sinus dilation studies was completed on patient-level data from six of our studies to evaluate long-term outcomes in a large patient sample and compare them with the outcomes from the REMODEL FESS cohort. The studies included the REMODEL randomized controlled trial balloon dilation arm and five prospective, multicenter, single-arm studies: XprESS Multi-Sinus, XprESS Maxillary Pilot, RELIEF, FinESS Registry, and BREATHE. Data were compiled from 358 patients with 846 treated sinuses. There were no statistically significant differences across studies for the demographics and baseline characteristics. Along with the final REMODEL results, the meta-analysis was published online on July 31, 2015, ahead of print publication in The Laryngoscope. It was subsequently published in the printed version in the January 2016 issue of The Laryngoscope.

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The meta-analysis demonstrated statistically significant and clinically meaningful improvements in mean SNOT-20 overall scores at all follow-up time points. For the 310 patients who received 12 month follow-up and the 74 patients who received 24 month follow up, the average decrease from baseline in the SNOT-20 score was 1.5 and 1.8, respectively. The results of the random effects model on the overall and subscale SNOT-20 scores are shown in the figure below. The changes in SNOT-20 scores were statistically significant, clinically meaningful, and durable through 24 months. A further analysis of variance comparison demonstrated no statistically significant differences between the SNOT-20 results from the FESS arm of the REMODEL trial, the balloon arm of the REMODEL trial and the five pooled single arm studies.

Meta-analysis Random Effect Model of Sino-Nasal Outcome Test (SNOT-20) Overall and Subscale Scores after Balloon Sinus Dilation

The meta-analysis results of the RSI scores indicated statistically significant improvements from baseline in both healthcare utilization and work/social measures. Using the Work Limitations Questionnaire work productivity was demonstrated to improve significantly in four of the five domains (time management, mental/interpersonal, outcome and productivity loss) for employed patients for up to two years after balloon sinus dilation. The meta-analysis was published online on July 31, 2015 along with the final REMODEL results in The Laryngoscope.

 

 

From: Chandra RK, et al. The Laryngoscope. 2016;126:44-50.

^a Comparison of mean change from baseline to follow-up; p value from paired t-test.

REMODEL Randomized Trial of Entellus Balloon Sinus Dilation versus FESS

We sponsored the REMODEL trial, which was a prospective, multicenter, randomized, controlled trial, in which 135 adult patients at 14 centers in the United States were treated between December 2011 and February 2013. The trial was designed to test the hypothesis that symptom improvement after balloon sinus dilation with our products in an ENT physician office was noninferior to FESS and that balloon sinus dilation with our products was superior to FESS for postoperative debridements. No study center contributed more than 20% of patient enrollments and results were consistent across sites. Patients were randomized one-to-one to either balloon sinus dilation or FESS.

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The two primary endpoints in the REMODEL trial were long-term improvement in sinus symptoms as assessed by the mean change in overall SNOT-20 QOL survey score between treatment and 12-month follow-up and the mean number of debridements per patient following treatment. Secondary and additional endpoints included the complication rate, recovery time, surgical revision rate, ostial patency, change in number of sinusitis episodes, and changes in activity impairment and work productivity. Post-procedure follow-up assessment of patients was performed at one week, and at months one, three, six and 12. A minimum of 36 patients were needed in each study arm to assess the primary endpoints with sufficient statistical power.

After randomization, 135 of 151 enrolled patients completed treatment. Fourteen patients randomized to FESS withdrew their consent for treatment. Eight of these patients indicated they were withdrawing because they did not want to undergo surgical treatment, one person indicated withdrawal because the person’s primary physician recommended not undergoing FESS, three indicated they were withdrawing due to other non-sinus medical conditions or a lack of time available for follow-up and two were found to have exclusion criteria upon further review. Two patients indicated they were withdrawing from the balloon sinus dilation arm of the study, with one of them doing so because they did not want to undergo the balloon procedure. Six-month follow-up was achieved in 133, or 98.5%, of the 135 patients who completed treatment. Twelve-month follow-up was achieved in 130, or 96.3% of the patients. Additionally, each of the 66 eligible patients completed 18-month follow-up and each of the 25 eligible patients completed 24-month follow-up. Patients in this trial had suffered with chronic sinusitis symptoms for an average of over 11 years and had not undergone a previous sinus surgery or balloon dilation procedure before study enrollment. The mean SNOT-20 score prior to treatment in the REMODEL study was 2.5 in each arm of the study.

Both primary endpoints were achieved in this trial. Comparison of changes between each trial group confirmed the mean symptom improvement for patients undergoing balloon sinus dilation was noninferior to that of patients undergoing FESS. Both trial groups experienced clinically meaningful and statistically significant improvements in overall SNOT-20 QOL survey scores. The mean number of postoperative debridements per patient showed a significant difference between the trial groups, demonstrating the superiority of balloon sinus dilation where patients in this group received an average of 0.2 debridements compared to an average of 1.0 debridements per patient in the FESS group.

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The trial demonstrated that when our balloon sinus dilation devices were used as a stand-alone therapy in the physician office setting, patients experienced similar efficacy rates in terms of symptom improvement, ostial patency, reduction of sinusitis episodes, and very low surgical revision rates, with faster recovery times, less bleeding at discharge, less use of prescription pain medication, and fewer post-procedure debridements than patients receiving FESS. The results of the final, larger cohort of 135 patients with between one and two years of follow-up, were published online on July 31, 2015, ahead of print publication in The Laryngoscope. The following table summarizes the final outcomes from the larger REMODEL trial cohort:

 

 

XprESS Pediatric Study

We sponsored the XprESS Pediatric Study, a prospective, multicenter, nonrandomized study, in which 50 pediatric patients ranging in age from two to 21 years were treated at four clinical centers in the United States from October 2014 to June 2015. The primary outcome measures were the procedural technical success rates and the complication rate through 3-month follow-up. Secondary outcome measures were changes in quality of life instruments and the revision surgery rate through 6-month follow-up. A total of 157 sinus dilations were attempted in 50 participants. All 157 dilation attempts were successfully completed for an overall XprESS technical success rate of 100%. No complications (0%) were reported. Significant improvement in sinus symptoms, as measured by the Sinus and Nasal Quality of Life Survey (SN-5), was seen between baseline and 6 months (4.6 vs 1.7, p<0.0001). A minimal clinically important difference threshold of 1.0 in the overall SN-5 score was achieved by 92% of the participants. FDA clearance for the expanded indication was received in November 2015. The expanded indication includes treatment of maxillary sinuses in patients two years and older, and treatment of the frontal and sphenoid sinuses in patients 12 years and older. We believe we are the only company to have received FDA clearance for balloon sinus dilation to treat the frontal and sphenoid sinuses in adolescents. The results of this study were published online on November 26, 2016, ahead of print publication in the International Forum for Allergy and Rhinology.

Eustachian Tube Study

In 2016, we completed enrollment for Phase 2 of our clinical study to treat Eustachian tube dysfunction with our XprESS device. This study is limited to 70 patients and follows the completion of Phase 1 of the study, which included 10 patients.

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Sales and Marketing and Physician Training

We have focused our sales and marketing efforts on educating ENT physicians about the clinical value, ease-of-use, convenience and cost-effectiveness of office-based sinus dilation as both an alternative to FESS for uncomplicated patients, and for patients who repeatedly fail aggressive medical management and are progressing toward becoming a surgical candidate. We also sell our products to ENT physicians who perform balloon sinus dilation in a hospital outpatient operating room or surgery center.

We maintain a direct sales organization in the United States, which as of December 31, 2016 consisted of 90 full quota-carrying representatives. We intend to continue to increase our presence outside the United States through expansion of our United Kingdom sales force and the addition of distributors. As of December 31, 2016, we had several distributors selling our products in over 10 countries.

Sales in the United States accounted for approximately 95% of our net revenues for the year ended December 31, 2016. Sales outside of the United States accounted for approximately 5% of our net revenues for the year ended December 31, 2016. Prior to 2015, we did not sell any products outside of the United States.

Our marketing group and clinically focused personnel support our sales personnel through the following initiatives:

Reimbursement and Procedure Economics

When balloon sinus dilation is performed adjunctively with standard FESS as a hybrid procedure, existing FESS codes are used and insurance coverage is available for an estimated 88% of covered lives in the United States as of December 2016.

Effective January 1, 2011, when balloon sinus dilation is performed as a stand-alone procedure, providers use CPT codes 31295, -96, and -97 for dilation of the maxillary, frontal, and sphenoid sinus ostia, respectively. When a stand-alone balloon procedure is performed in the physician office, the reimbursement associated with these CPT codes includes a non-facility practice expense component of payment intended to cover the cost of equipment, supplies, and overhead associated with these procedures performed in the physician office, including the cost of our devices. In addition, physicians receive additional value from the convenience and efficiency of treating patients in their office setting compared to treatments in a hospital or surgery center. We believe that this, along with excellent clinical outcomes, motivates many ENT physicians and practices to adopt our balloon sinus dilation products.

As an example of cost savings to the healthcare system from office balloon sinus dilation procedures, the 2017 Medicare national average payment rate to a physician performing bilateral maxillary sinus dilation in the office and a nasal endoscopy exam one week later is $3,297. By comparison, treating the same patient with FESS, including ethmoidectomy in an ASC, and performing a debridement one week later costs Medicare $5,749, or 54% more, including ENT physician professional fees of $968. Treating that same patient with FESS, including ethmoidectomy in a hospital out-patient department with a debridement one week later costs Medicare, $5,749, or 74% more than balloon sinus dilation office treatment. When more complex cases are performed involving dilation of four or six sinuses, the level of savings to the healthcare system for office sinus dilation increases. Publication in November 2016 by the Centers for Medicare & Medicaid Services, or CMS, the federal agency responsible for administering the Medicare program, of final 2017 payment rates for stand-alone balloon sinus dilation resulted in 2017 rates very similar to 2016 rates.

 

 

Note: National average payment rates include the total reimbursement made to physicians and facilities for the balloon sinus dilation or FESS procedure plus cost of post-FESS debridement or post-balloon sinus dilation nasal endoscopy. Ethmoidectomy is performed with all FESS procedures.

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Medicare issued a final rule on the Hospital Outpatient Prospective Payment System, or OPPS, for 2017 which includes a reduction of payments for certain outpatient procedures performed in the hospital when FESS is performed on more than two sinuses. The result is to bundle payments for multi-sinus surgery regardless of the number of sinuses being treated. On average, we expect most hospitals will experience a reduction in CMS reimbursement depending on the number of sinuses being treated.

As of December 2016, third-party payor insurance coverage for stand-alone balloon sinus dilation procedures is available for an estimated 230 million persons in the United States, which represents 80% of covered lives. Positive coverage decisions for stand-alone balloon sinus dilation performed in the physician office setting are in place with several third-party payors including Medicare, United Healthcare, Aetna, Cigna, Humana, Kaiser Permanente, TRICARE, Health Net and in certain states Medicaid and Blue Cross Blue Shield plans. Balloon sinus dilation has the support of the American Academy of Otolaryngology and the American Rhinological Society, both of which have written positive policy statements for balloon sinus treatment and participate in efforts to obtain coverage.

In December 2016, NICE provided positive guidance for use of our XprESS Multi-Sinus Dilation System in the United Kingdom, recommending it for use in patients with uncomplicated chronic sinusitis who do not have severe nasal polyposis. In these patients, NICE has asserted that, in comparison with FESS, our XprESS Multi-Sinus Dilation System works as well, is associated with faster recovery times and can more often be performed under local anesthesia. The NICE guidance indicates that our XprESS Multi-Sinus Dilation System is cost saving compared to FESS based on device cost, length of FESS procedure and assuming the treatments are performed under local anesthetic, in an outpatient setting. NICE estimates that, by adopting our technology, the National Health Service in England may save up to £7.4 million per year by 2020. The NICE guidance is specific to the XprESS Multi-Sinus Dilation System and does not extend to any other balloon sinus dilation technology.

With the benefit of cost savings from office-based balloon sinus dilation procedures, we believe the combination of clinical and cost advantages will lead to additional coverage as payors become more knowledgeable about the full body of clinical evidence. However, there can be no assurance that payors will continue to cover stand-alone balloon sinus dilation, or that additional payors will issue positive coverage policies for the procedure.

Competition

Our industry is highly competitive, subject to change and significantly affected by activities of industry participants. We compete with companies and products used to treat chronic sinusitis, including traditional FESS, medical therapies and other balloon sinus dilation products. Our balloon sinus dilation products compete with medical management by providing a procedure and treatment option that may be chosen to be performed by ENT physicians after fewer rounds of medical management than historically employed due to the minimally disruptive nature of balloon sinus dilation as compared to FESS. Our balloon sinus dilation products compete with FESS by providing a comparably effective in-office alternative for patients with uncomplicated sinusitis. Accordingly, our balloon sinus dilation products are increasingly positioned in the middle of the treatment continuum between medical management and FESS, drawing patients from medical management who might not have chosen any treatment beyond medical management due to the invasive nature of FESS, as well as patients who would have chosen FESS if not for our less invasive alternative. Our balloon sinus dilation products also compete with other companies selling balloon sinus dilation products to ENT physicians. Our MiniFESS and other products also compete with companies selling devices for use in balloon sinus dilation. Additionally, ENT physicians may use competing devices, instead of our MiniFESS or other products, to confirm sinus location and placement of our XprESS device.

Many of the companies developing or marketing these competitive products are publicly traded or are divisions of publicly traded companies. These companies may enjoy several competitive advantages over us, including:

Companies that sell balloon sinus dilation products include the Acclarent division of Johnson and Johnson Inc., the market leader in balloon sinus dilation products, as well as the Xomed division of Medtronic, plc, and the ArthroCare division of Smith & Nephew, plc. In addition, a small private company, SinuSys Corporation, sells a non-balloon sinus dilation system that uses osmotic self-expansion technology. Companies that provide tools and devices for FESS include the Xomed division of Medtronic, plc, the Gyrus ACMI division of Olympus and Stryker Corporation. Intersect ENT, Inc. sells a steroid-eluting biodegradable stent that is used following FESS or in patients who have previously undergone an FESS procedure and is not currently a competitor. However, Intersect ENT is currently developing products for office-based treatment of sinusitis, which if approved may be competitive with us in the future.

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We believe our continued ability to compete favorably depends on:

Intellectual Property

We believe that the strength of our competitive position depends substantially upon our ability to obtain and enforce intellectual property rights protecting our technology. We apply for patents for new patentable technologies relevant to our business and utilize other forms of intellectual property protection to strategically protect our intellectual property. Periodically, we may review and attempt to acquire rights in third-party patents and applications that we deem strategically valuable.

Patents

As of December 31, 2016, we owned at least 33 issued U.S. patents relating to the field of sinusitis treatment and had at least 19 pending patent applications for U.S. patents. As of December 31, 2016, at least 13 of those issued patents and 7 of our pending patent applications included claims directed towards the XprESS family of products and methods of using the XprESS products.

Many of the issued patents that protect our commercial products and current product pipeline are derived from applications that were filed between 2006 and 2009. Since U.S. law provides for a 20-year patent term measured from the date of filing, those patent holdings will begin to expire starting in 2026, though a number of those patents enjoy patent term extensions granted by the U.S. Patent Office. While we have pursued and continue to pursue patent protection for our technologies, we may, from time to time, abandon certain patents and patent applications for business reasons.

Trademarks

Our trademark portfolio as of December 31, 2016 included the XPRESS, PATHASSIST, FINESS, ENTELLUS MEDICAL, LIGHT FIBER, LIGHT SEEKER, FOCESS, CYCLONE, XEROGEL and MINIFESS marks.

Trade Secrets

We may rely, in some circumstances, on trade secret law to protect portions of our technology. Trade secrets, however, can be difficult to protect.

We seek to protect our proprietary technology and manufacturing processes, in part, by confidentiality and invention assignment agreements with employees, under which they are bound to assign to us inventions that are made during the term of their employment and relate to our business, unless otherwise accepted. These agreements further prohibit our employees from using, disclosing, or bringing onto the premises any proprietary information belonging to a third-party. In addition, most of our consultants, scientific advisors and contractors are required to sign agreements under which they must assign to us any inventions that relate to our business. These agreements also prohibit these third-parties from incorporating into any inventions the proprietary rights of third-parties without informing us. It is our policy to require all employees to document potential inventions and other intellectual property in laboratory notebooks and to disclose inventions to patent counsel. We also seek to preserve the integrity and confidentiality of our data and trade secrets by maintaining physical security of our premises and physical and electronic security of our information technology systems.

While we have confidence in these individuals, organizations and systems, agreements or security measures may be breached and we may not have adequate remedies for any breach. In addition, our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our consultants, contractors or collaborators use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

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License Agreement with Acclarent, Inc.

In February 2011, we entered into a license agreement with Acclarent, Inc. in connection with the settlement of a then-ongoing litigation in which Acclarent alleged that our FinESS and XprESS products infringed certain claims of five of their patents, which allegations we denied. In October 2012, we agreed with Acclarent to amend certain terms of our license agreement, or, as amended, the Acclarent License. Pursuant to the Acclarent License, Acclarent granted us a worldwide, non-exclusive, royalty-bearing license under certain patents held by Acclarent to manufacture, use and commercialize our currently marketed XprESS, PathAssist and FinESS products and certain future versions of those products, or, collectively, the Covered Products, in the field of the expansion of paranasal sinuses and sinus pathways.

Under the Acclarent License, we made an initial up-front, lump-sum payment to Acclarent as a retroactive royalty payment. We are also required to pay Acclarent an ongoing royalty in the low double-digit percentages, on a country-by-country basis, on net sales of Covered Products. The Acclarent License will expire upon the expiration or abandonment of the last to expire of the patents licensed to us under the agreement. Acclarent has the right to terminate the agreement upon 60 days’ notice in the event of our uncured material breach.

Manufacturing and Supply

We manufacture and assemble the majority of our products at our facility in Plymouth, Minnesota using components from external suppliers. XeroGel nasal packing material is manufactured at our leased facility in Hayward, California. We perform inspections of all components before use. Using these components, we assemble, inspect, test and package our products and, when appropriate, send them to a third-party sterilization vendor. After sterilization (when required), we perform additional inspections of the finished products, carton and label products internally and release the lot to inventory and then ship the finished product to customers. Certain other of our products are manufactured for us pursuant to distributor and other agreements, such as Fiagon IGS.

We believe our manufacturing operations are in compliance with regulations mandated by the FDA. We are an FDA-registered medical device manufacturer. Our manufacturing facilities and processes are subject to periodic inspections and audits by various federal, state and foreign regulatory agencies. For example, our facilities were inspected by the FDA in May 2015, and no major nonconformance reports were issued as a result of that inspection. Our facility was last inspected in October 2016 by the British Standards Institute, our Notified Body, and no major nonconformance reports were issued as a result of that inspection.

Certain components used in our products are supplied to us from single source suppliers. We rely on single-source suppliers for some of our balloon extrusions and molded components and some off-the-shelf components. We generally acquire our single-source components pursuant to purchase orders placed in the ordinary course of business. While our suppliers have generally met our demand for their products on a timely basis in the past, we are not certain that they will in the future be able to meet our demand for their products, either because of the nature of our agreements with those suppliers, our limited experience with those suppliers, or our relative importance as a customer to those suppliers.

Our suppliers manufacture the components they produce for us or test our components and devices to our specifications. We intend to maintain sufficient supplies of the components from these single-source suppliers in the event that one or more of these suppliers were to encounter delay in supply or end supply to enable us to continue to manufacture our products for a sufficient amount of time necessary to obtain another source of components.

Government Regulation

The design, development, research, manufacture, testing, labeling, promotion, advertising, distribution, marketing, sale and export and import of our products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies. Failure to obtain or maintain approval or clearance to market our products or to meet the ongoing requirements of these regulatory authorities could prevent us from marketing and continuing to market our products.

Regulation by the FDA

In the United States, the Federal Food, Drug, and Cosmetic Act, FDA regulations and other federal and state statutes and regulations govern, among other things, medical device design and development, preclinical and clinical testing, device safety, premarket clearance or approval, registration and listing, manufacturing, labeling, storage, record-keeping procedures, advertising and promotion, sales and distribution, export and import, recalls and field safety corrective actions, and post-market surveillance, including complaint handling and medical device reporting. The FDA regulates the design, manufacturing, servicing, sale and distribution of medical devices. Failure to comply with applicable U.S. requirements may subject a company to a variety of administrative or judicial sanctions, such as warning or untitled letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties and criminal prosecution. The FDA can also refuse to approve or clear pending applications.

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Each medical device we wish to distribute commercially in the United States requires marketing authorization from the FDA prior to distribution either through the 510(k) premarket notification process or the more demanding premarket approval, or PMA, process, unless an exemption applies. The type of marketing authorization necessary is generally linked to the classification of the device. The FDA classifies medical devices into one of three classes (Class I, II, or III) based on the degree of risk associated with a device and the level of regulatory control deemed necessary to ensure its safety and effectiveness. Low- and moderate-risk devices requiring fewer controls are placed in Class I or II. Class I devices that pose the least risk are subject only to the general controls applicable to all devices, such as requirements for device labeling, premarket notification and adherence to the FDA’s current good manufacturing practices, or cGMPs, as reflected in the Quality System Regulation, or QSR. Class II devices that pose a moderate risk are subject to general controls and may also be subject to special controls such as performance standards, product-specific guidance documents, special labeling requirements, patient registries, or post-market surveillance. Class III devices are those for which insufficient information exists to assure safety and effectiveness solely through general or special controls, including devices that support or sustain human life, are of substantial importance in preventing impairment of human health, or which present a potential, unreasonable risk of illness or injury.

Most Class I devices and some Class II devices are exempted by regulation from the 510(k) clearance requirement and can be marketed without prior authorization from the FDA. Some Class I devices that have not been so exempted and Class II devices are eligible for marketing through the 510(k) clearance pathway. By contrast, devices placed in Class III generally require PMA approval or 510(k) de novo classification prior to commercial marketing. The PMA approval process is more stringent, time-consuming and expensive than the 510(k) clearance process; however, the 510(k) clearance process has also become increasingly stringent and expensive.

Medical Devices. Each of our current commercially available devices is classified as either a Class I device exempt from the requirement to submit a 510(k) notification, or as a Class I or Class II device requiring 510(k) clearance. None of our current commercially available devices is classified as a Class III device requiring PMA approval.

510(k) Clearance. To obtain 510(k) clearance for a medical device, an applicant must submit a premarket notification to the FDA demonstrating that the device is “substantially equivalent” to a legally marketed device, commonly known as the “predicate device.” A legally marketed predicate device may include a device that was legally marketed in the United States prior to May 28, 1976 for which a PMA is not required (commonly known as a “pre-amendment device” based on the date the Medical Device Amendments of 1976 were enacted), a device which the FDA has reclassified from Class III to Class II or I, or a device which has been found substantially equivalent through the 510(k) process. A device is substantially equivalent if, with respect to the predicate device, it has the same intended use and has either (i) the same technological characteristics, or (ii) different technological characteristics, but the information provided in the 510(k) submission demonstrates that the device does not raise new questions of safety and effectiveness and is at least as safe and effective as the predicate device. A showing of substantial equivalence sometimes, but not always, requires clinical data.

Before the FDA will accept a 510(k) submission for substantive review, the FDA will first assess whether the submission satisfies a minimum threshold of acceptability. If the FDA determines that the 510(k) submission is incomplete, the FDA will issue a “Refuse to Accept” letter which generally outlines the information the FDA believes is necessary to permit a substantive review and to reach a determination regarding substantial equivalence. An applicant must submit the requested information before the FDA will proceed with additional review of the submission. Once the 510(k) submission is accepted for review, by regulation, the FDA has 90 days to review and issue a determination. As a practical matter, clearance often takes longer. The FDA may require additional information, including clinical data, to make a determination regarding substantial equivalence. Unless a specific exemption applies, 510(k) premarket notification submissions are subject to user fees.

Medical devices can be marketed only for the indications for which they are cleared or approved. After a device has received 510(k) clearance for a specific intended use, any change or modification that significantly affects its safety or effectiveness, such as a significant change in the design, materials, method of manufacture or intended use, may require a new 510(k) clearance or PMA approval and payment of an FDA user fee. The determination as to whether or not a modification could significantly affect the device’s safety or effectiveness is initially left to the manufacturer using available FDA guidance; however, the FDA may review this determination to evaluate the regulatory status of the modified product at any time and may require the manufacturer to cease marketing and recall the modified device until 510(k) clearance or PMA approval is obtained. The manufacturer may also be subject to significant regulatory fines or penalties.

PMA Approval. A PMA must be submitted to the FDA if the device is classified in Class III or otherwise cannot be cleared through the 510(k) process (although the FDA has discretion to continue to allow certain pre-amendment Class III devices to use the 510(k) process). PMA applications must be supported by, among other things, valid scientific evidence demonstrating the safety and effectiveness of the device, which typically requires extensive data, including technical, preclinical, clinical and manufacturing data. A PMA application must also include, among other things, a complete description of the device and its components, a detailed description of the methods, facilities and controls used to manufacture the device, and proposed labeling. FDA regulations provide 180 days for the FDA to review a PMA application and make a determination, although the process typically takes significantly longer, and may require several years to complete. In addition, the FDA will conduct a pre-approval inspection of the applicant or its

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third-party manufacturers’ or suppliers’ manufacturing facilities to ensure compliance with the QSR, which requires manufacturers to follow design, testing, control, documentation and other quality assurance procedures.

None of our products are currently approved pursuant to a PMA, and we have no plans for any indication or system improvement or extension that we believe would require a PMA.

Clinical Trials

Clinical trials are generally required to support a PMA application and are sometimes required for 510(k) clearance. Such trials generally require submission of an investigational device exemption, or IDE, application to the FDA for a specified number of patients and study sites, unless the product is deemed a non-significant risk device eligible for more abbreviated IDE requirements. If an IDE is required, the FDA and the appropriate institutional review boards, or IRBs, at the clinical sites must approve the study before clinical trials may begin. Clinical trials are subject to extensive monitoring, record keeping and reporting requirements. Clinical trials must be conducted under the oversight of an IRB for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices. To conduct a clinical trial, the patient’s informed consent must be obtained in form and substance that complies with both FDA requirements and state and federal privacy and human subject protection regulations. The clinical trial sponsor, the FDA or the IRB could suspend or terminate a clinical trial at any time for various reasons, including a belief that the subjects are being exposed to an unacceptable health risk. Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and effectiveness of the device or may otherwise not be sufficient to obtain FDA clearance or approval to market the product.

In September 2016, following an inspection of certain documentation relating to our prospective, multicenter study of children with chronic rhinosinusitis treated with the XprESS™ Multi-Sinus Dilation System, the FDA issued a Form 483, List of Inspectional Observations, containing two observations. The first observation relates to not obtaining FDA and IRB approval for changes to an investigational plan and the second observation relates to not ensuring prompt compliance with the study protocol by clinical investigators. These observations relate to study deviations which occurred when some physicians decided to treat sinuses outside of the scope of the study protocol due to medical necessity thereby avoiding the need for a follow-on procedure. Following our receipt of the Form 483, we implemented and completed corrective and preventive actions we believe fully address the FDA observations, and we provided written responses to the FDA detailing these corrective and preventive actions completed. The outcome of this matter is presently uncertain, and we cannot provide assurance that the FDA will conclude that our corrective and preventive actions are adequate to address the observations. If the FDA is not satisfied, they may issue a warning letter to us, which could have a material adverse effect on our business.

Continuing FDA Regulation

Any devices we manufacture or distribute pursuant to 510(k) clearance or PMA approval by the FDA are subject to pervasive and continuing regulation by the FDA and certain state agencies. These include product listing and establishment registration requirements, which help facilitate FDA inspections and other regulatory actions. We are required to adhere to applicable cGMP requirements, as set forth in the QSR, which require, manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all phases of the design and manufacturing process. Noncompliance with these regulations can result in, among other things, fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspension of production, FDA refusal to grant 510(k) clearance or PMA approval to new devices, withdrawal of existing clearances or approvals, and criminal prosecution.

We must also comply with post-market surveillance regulations, including medical device reporting, or MDR, requirements which require that we review and report to the FDA any incident in which our products may have caused or contributed to a death or serious injury, and any incident in which our product has malfunctioned if that malfunction would likely cause or contribute to a death or serious injury if it were to recur. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Medical devices approved or cleared by the FDA may not be promoted for unapproved or uncleared uses, otherwise known as “off-label” promotion. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability, including substantial monetary penalties and criminal prosecution.

Failure to comply with applicable regulatory requirements, including delays in or failures to report incidents to the FDA as required under the MDR regulations or off-label promotion, can result in enforcement action by the FDA which can include any of the following sanctions:

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We cannot guarantee that we have adequately complied with all regulatory requirements. If any of these events were to occur, they could have a material adverse effect on our business.

European Union’s Regulation of Medical Devices

The European Union has adopted legislation, in the form of directives to be implemented in each Member State, concerning the regulation of medical devices within the European Union. The directives include, among others, the Medical Device Directive (Council Directive 93/42/EEC) that establishes certain requirements, i.e. the essential requirements, with which medical devices must comply before they can be commercialized in the EEA (which is comprised of the Member States of the European Union plus Norway, Liechtenstein and Iceland). Under the European Union Medical Device Directive, medical devices are classified into four Classes, I, IIa, IIb and III, with Class I being the lowest risk and Class III being the highest risk. Under the Medical Device Directive, a competent authority is nominated by the government of each Member State to monitor and ensure compliance with the Directive. To demonstrate compliance of their medical devices with the essential requirements, manufacturers must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Except for certain types of low-risk medical devices (Class I non‑sterile, non‑measuring devices), where the manufacturer can issue an EC Declaration of Conformity based on a self-assessment of the conformity of its products with the essential requirements of the Medical Devices Directive, a conformity assessment procedure requires the intervention of an organization accredited by a Member State of the EEA to conduct conformity assessments, which is referred to as a Notified Body. The Notified Body would typically audit and examine the quality system for the manufacture, design and final inspection of the medical devices before issuing a certification demonstrating compliance with the essential requirements. Medical devices that comply with the essential requirements are entitled to bear the CE mark. CE is an abbreviation for Conformité Européene, or European Conformity. Medical devices properly bearing the CE mark may be commercially distributed throughout the EEA. Additional pre-market approvals in individual EEA countries are sometimes required prior to marketing of a product. Failure to maintain the CE mark would preclude us from selling our products in the EEA, as could failure to comply with the specific requirements of the Member States.

In September 2012, the European Commission published proposals for the revision of the EU regulatory framework for medical devices. The proposals would replace the Medical Devices Directive with a new regulation, or the Medical Devices Regulation.. Unlike the Directives that must be implemented into national laws, the Medical Devices Regulation would be directly applicable in all EEA Member States and so is intended to eliminate current national differences in regulation of medical devices. In October 2013, the European Parliament approved a package of reforms to the European Commission's proposals. Under the revised proposals, only designated “special notified bodies” would be entitled to conduct conformity assessments of high-risk devices. These special notified bodies will need to notify the European Commission when they receive an application for a conformity assessment for a new high-risk device. The European Commission will then forward the notification and the accompanying documents on the device to the Medical Devices Coordination Group, a new, yet to be created body chaired by the European Commission and consisting of representatives of Member States, for an opinion.

In June 2016, the Council of the European Union’s Permanent Representatives Committee endorsed the agreement reached with the European Parliament on the proposed Medial Devices Regulation. It is expected that the final regulation will be largely unchanged from the proposed regulation.  Formal publication of the regulation in the Official Journal of the European Union and entry into force is expected in May 2017, followed by a three year transition period. The regulation incorporates a product life-cycle approach similar to the one used by FDA, which follows a device from conceptualization all the way through end of life. In general, this will include stronger premarket and post-market surveillance requirements and require manufacturers to continually evaluate products they have placed on the market. Additional changes include stricter oversight and requirements for notified bodies, additional requirements for clinical evidence, strengthened rules for high-risk devices, and increased transparency and traceability for the medical device industry as a whole. These new rules and procedures may result in increased regulatory oversight of certain devices and this may, in turn, increase the costs, time and requirements that need to be met in order to maintain or place such devices on the EEA market.

Further, the advertising and promotion of our products in the EEA is subject to the laws of individual EEA Member States implementing the EU Medical Devices Directive, Directive 2006/114/EC concerning misleading and comparative advertising, and Directive 2005/29/EC on unfair commercial practices, as well as other EEA Member State laws governing the advertising and promotion of medical devices. These laws may limit or restrict the advertising and promotion of our products to the general public and may impose limitations on our promotional activities with healthcare professionals. In the EEA, our European operations must comply with the EU Medical Device Vigilance System, the purpose of which is to improve the protection of health and safety of patients, users and others by reducing the likelihood of reoccurrence of incidents related to the use of a medical device. Under this system, incidents must be reported to the Competent Authorities of the Member States of the EEA. An incident is defined as any malfunction or deterioration in the characteristics and/or performance of a device, as well as any inadequacy in labeling or instructions that may,

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directly or indirectly, lead or have led to death or serious health deterioration of a patient. Incidents are evaluated by the EEA Competent Authorities to whom they have been reported, and where appropriate, information is disseminated between them in the form of National Competent Authority Reports, or NCARs. The Medical Device Vigilance System is further intended to facilitate a direct, early and harmonized implementation of Field Safety Corrective Actions, or FSCAs, across the Member States of the EEA where the device is in use. An FSCA is an action taken by a manufacturer to reduce a risk of death or serious deterioration in the state of health associated with the use of a medical device that is already placed on the market. An FSCA may include the recall, modification, exchange, destruction or retrofitting of the device. FSCAs must be communicated by the manufacturer or its legal representative to its customers and/or to the end users of the device through Field Safety Notices.

U.S. Anti-Kickback, False Claims and Other Healthcare Laws

We are also subject to healthcare regulation and enforcement by the U.S. federal government and the states as well as foreign governments and other authorities in the locations in which we conduct our business. These other agencies include, without limitation, CMS, other divisions of the U.S. Department of Health and Human Services, the U.S. Department of Justice and individual U.S. Attorney offices within the Department of Justice, as well as state and local governments. Such agencies enforce a variety of laws including, without limitation, state and federal anti-kickback, fraud and abuse, false claims, data privacy and security, and physician transparency laws and regulations.

The federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving any remuneration (including any kickback, bribe or rebate), directly or indirectly, overtly or covertly, to induce or in return for purchasing, leasing, ordering or arranging for or recommending the purchase, lease or order of any good, facility, item or service reimbursable, in whole or part by Medicare, Medicaid or other federal healthcare programs. The term “remuneration” has been broadly interpreted to include anything of value, including cash, improper discounts, and free or reduced price items and services. Among other things, the Anti-Kickback Statute has been interpreted to apply to arrangements between medical device manufacturers on the one hand and prescribers and purchasers on the other. Although there are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, these exceptions and safe harbors are technical in nature and narrowly drawn. Practices that involve remuneration that may be alleged to be intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exception or safe harbor. Failure to meet all of the requirements of a particular applicable statutory exception or regulatory safe harbor does not make the conduct per se illegal under the Anti-Kickback Statute. Instead, the legality of the arrangement will be evaluated on a case-by-case basis based on a cumulative review of all of its facts and circumstances with prosecutorial discretion. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the Anti-Kickback Statute has been violated. In addition, committing a violation does not require a person or entity has actual knowledge of the statute or specific intent to violate. Further, a claim including items or services resulting from a violation of the federal Anti-Kickback Statute also could constitute a false or fraudulent claim for purposes of the federal civil False Claims Act.

The federal civil False Claims Act prohibits, among other things, any person or entity from knowingly presenting, or causing to be presented, a false or fraudulent claim for payment to or approval by the federal government or knowingly making, using or causing to be made or used a false record or statement material to a false or fraudulent claim to the federal government. A claim includes “any request or demand” for money or property presented to the U.S. government. Violations of the False Claims Act can result in very significant monetary penalties and treble damages. The federal government is using the False Claims Act, and the accompanying threat of significant liability, in its investigation and prosecution of medical device companies throughout the country, for example, in connection with the promotion of products for unapproved uses and other sales and marketing practices. The government has obtained multi-million and multi-billion dollar settlements under the False Claims Act in addition to individual criminal convictions under applicable criminal statutes. In addition, the federal civil monetary penalties statute imposes penalties against any person or entity that, among other things, is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent. Given the significant size of actual and potential settlements, it is expected that the government will continue to devote substantial resources to investigating healthcare providers’ and manufacturers’ compliance with applicable fraud and abuse laws.

The federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, contains federal criminal statutes that prohibit knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private third-party payors and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. Similar to the Anti-Kickback Statute a person or entity does not need to have actual knowledge of these statutes or specific intent to violate them in order to have committed a violation.

Also, many states have similar fraud and abuse statutes or regulations that may be broader in scope and may apply regardless of payor, in addition to items and services reimbursed under Medicaid and other state programs.

We may also be subject to data privacy and security regulation by both the federal government and the states in which we conduct our business. HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH,

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and their respective implementing regulations, imposes specified requirements relating to the privacy, security and transmission of individually identifiable health information. Among other things, HITECH makes HIPAA’s security standards directly applicable to business associates, defined as service providers of covered entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also contains four tiers of civil monetary penalties and gives state attorneys general authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions. In addition, many state laws govern the privacy and security of health information in certain circumstances, many of which differ from HIPAA and each other in significant ways and may not have the same effect.

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education and Reconciliation Act, or collectively, the Affordable Care Act, imposes, among other things, annual reporting requirements for covered manufacturers of devices for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program, for certain payments and “transfers of value” provided to physicians and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members. Failure to submit timely, accurately and completely the required information for all payments, transfers of value and ownership or investment interests may result in civil monetary penalties of up to an aggregate of $150,000 per year and up to an aggregate of $1 million per year for “knowing failures.” Covered manufacturers must submit reports by the 90th day of each calendar year. In addition, certain states require implementation of commercial compliance programs and compliance with the device industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government, impose restrictions on marketing practices, and/or tracking and reporting of gifts, compensation and other remuneration or items of value provided to physicians and other healthcare professionals and entities.

These laws impact the kinds of financial arrangements we may have with hospitals, physicians or other potential purchasers of our products. They particularly impact how we structure our sales offerings, including discount and rebate practices, customer support, education and training programs, physician consulting, research grants and other arrangements. If our operations are found to be in violation of any of the health regulatory laws described above or any other laws that apply to us, we may be subject to penalties, including potentially significant criminal, civil and/or administrative penalties, damages, fines, disgorgement, exclusion from participation in government healthcare programs, contractual damages, reputational harm, administrative burdens, diminished profits and future earnings, and the curtailment or restructuring of our operations.

Coverage and Reimbursement

Our currently cleared products are treated as supplies utilized in balloon sinus dilation procedures and if covered by third-party payors, are typically paid for as part of a stand-alone balloon sinus dilation procedure or as a part of FESS if used in conjunction with FESS. Failure by physicians, hospitals, ASCs and other users of our products to obtain sufficient coverage and reimbursement from healthcare payors for procedures in which our products are used, or adverse changes in government and private third-party payors’ coverage policies would have a material adverse effect on our business.

In the United States, third-party payors continue to implement initiatives that restrict the use of certain technologies to those that meet certain clinical evidentiary requirements. We are aware of a number of third-party payors in the United States, including without limitation Anthem/Wellpoint and certain Blue Cross Blue Shield plans that consider stand-alone balloon sinus dilation procedures to be experimental or investigational. Failure to obtain and maintain favorable coverage policies could have a material adverse effect on our business and operations. In the international markets reimbursement and healthcare payment systems vary significantly by country. Market acceptance of our products is dependent upon the different types of healthcare payment systems including government-sponsored healthcare, private insurance and self-paid.

In addition to uncertainties surrounding coverage policies, there are periodic changes to reimbursement. Third-party payors regularly update reimbursement amounts and also from time to time revise the methodologies used to determine reimbursement amounts. This includes, among other things, annual updates to payments to physicians, hospitals and ASCs for procedures during which our products are used. Because the cost of our products generally is recovered by the healthcare provider as part of the payment for performing a procedure and not separately reimbursed, these updates could directly impact the demand for our products. An example of payment updates is the Medicare program’s updates to hospital and physician payments, which are done on an annual basis using a prescribed statutory formula. In the past, when the application of the formula resulted in lower physician payments, Congress has passed interim legislation to prevent the reductions. However, the Medicare Access and CHIP Reauthorization Act of 2015, or MACRA, ended the use of the statutory formula, and provided for a 0.5% annual increase in payment rates under the Medicare Physician Fee Schedule through 2019 but no annual update from 2020 through 2025. MACRA also introduced a merit-based incentive bonus program for Medicare physicians beginning in 2019. At this time it is unclear how the introduction of the merit based incentive program will impact overall physician reimbursement under the Medicare program. Any changes in coverage and reimbursement that further restrict coverage of our products or lower reimbursement for procedures using our devices could materially affect our business.

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Healthcare Reform

Current and future legislative proposals to further reform healthcare or reduce healthcare costs may limit coverage for the procedures associated with the use of our products, or result in lower reimbursement for those procedures. The cost containment measures that payors and providers are instituting and the effect of any healthcare reform initiative implemented in the future could significantly reduce our revenues from the sale of our products.

By way of example, the Affordable Care Act substantially changed healthcare financing and delivery by both governmental and private insurers, and significantly impacted the pharmaceutical and medical device industries. The Affordable Care Act imposed, among other things, a new federal excise tax on the sale of certain medical devices, provided incentives to programs that increase the federal government’s comparative effectiveness research, and implemented payment system reforms including a national pilot program on payment bundling to encourage hospitals, physicians and other providers to improve the coordination, quality and efficiency of certain healthcare services through bundled payment models. Under the Consolidated Appropriations Act, 2016, the excise tax has been suspended from January 1, 2016 to December 31, 2017, and, absent further legislative action, will be reinstated starting January 1, 2018.

In addition, other legislative changes have been proposed and adopted since the Affordable Care Act was enacted. On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, due to subsequent legislative amendments, will stay in effect through 2025 unless additional Congressional action is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012, was signed into law, which, among other things, further reduced Medicare payments to several providers, including hospitals.

We expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, which could result in reduced demand for our products or additional pricing pressure.

Research and Development

Realizing that new product offerings are relevant to our future success, we are committed to a strong research and development program. Our research and development efforts are focused primarily on enhancing our XprESS family of products and broadening their indications for use, as well as developing new related products. Our research and development program consists primarily of engineering, product development and clinical studies to develop and support our current products, products and technologies in development and next generation versions of current products. Our internal research and development team works closely with external research and development consultants and a network of physicians and medical personnel to ensure we have broad access to best-in-class ideas and technologies to drive our product development pipeline. We also have an active business development team that actively evaluates technologies and products. In addition, our clinical and regulatory departments are devoted to verifying the safety and efficacy of our products according to regulatory standards enforced by the FDA and other international regulatory bodies. Our research and development expenses totaled $7.8 million, $5.4 million and $4.3 million in 2016, 2015 and 2014, respectively.

Employees

As of December 31, 2016, we had approximately 280 employees. We have never had a work stoppage and none of our employees are covered by collective bargaining agreements. We believe our employee relations are good.

Financial Information

We operate in one reportable segment, which we have presented as the aggregation of our sinusitis product families. Within this reportable segment we are organized on the basis of the products and services we provide which are used for the treatment of chronic and recurrent sinusitis. See Note B—Summary of Significant Accounting Policies—Segment, Geographical and Customer Concentration and Note N—Segment and Geographic Data of the Notes to Consolidated Financial Statements to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for financial information regarding segment reporting and our revenue and long-lived assets by geographic region.

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Other Information

We are incorporated in Delaware as Entellus Medical, Inc. Our offices are located at 3600 Holly Lane North, Suite 40, Plymouth, MN 55447. Our telephone number is (763) 463-1595. Our corporate website is www.entellusmedical.com. The information contained on or that can be accessed through our website is not incorporated by reference into this Annual Report on Form 10-K. We make available, free of charge through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after we electronically file these materials with, or otherwise furnish them to, the SEC.

Implications of Being an Emerging Growth Company

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and, for so long as we are an emerging growth company, are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. These include, but are not limited to:

We may remain an “emerging growth company” until as late as December 31, 2020, the fiscal year-end following the fifth anniversary of the completion of our initial public offering, or IPO, though we may cease to be an “emerging growth company” earlier under certain circumstances, including if (1) we have more than $1.0 billion in annual revenue in any fiscal year, (2) the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 or (3) we issue more than $1.0 billion of non-convertible debt over a three-year period.

In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of such extended transition period. Section 107 of the JOBS Act provides that we can elect to opt out of the extended transition period at any time, which election is irrevocable.

 

 

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Our business faces significant risks and uncertainties.  Certain important factors may have a material adverse effect on our business prospects, financial condition and results of operations, and you should carefully consider them.  Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors, in its entirety, in addition to other information contained in or incorporated by reference into this Annual Report on Form 10-K and our other public filings with the SEC.  Other events that we do not currently anticipate or that we currently deem immaterial may also affect our business, prospects, financial condition and results of operations.

Risks Related to Our Business

We have incurred operating losses since inception, we expect to incur operating losses in the future and we may not be able to achieve or sustain profitability.

We have incurred net losses since our inception in 2006. Our net loss for the year ended December 31, 2016 was $28.7 million. As of December 31, 2016, we had an accumulated deficit of $150.8 million. To date, we have financed our operations primarily through the completion of our IPO, our underwritten public offering of common stock in the first quarter of 2017, private placements of our convertible preferred securities prior to our IPO, certain debt-related financing arrangements and from sales of our products. We have devoted substantially all of our resources to research and development of our products, clinical and regulatory initiatives to obtain clearances or approvals for our products, sales and marketing activities and operating as a public company. Our ability to generate sufficient revenue from our existing products or from any of our products in development, to transition to profitability and generate consistent positive cash flows, is uncertain. We expect that our operating expenses will continue to increase as we continue to build our commercial infrastructure, and develop, enhance and commercialize new products. In addition, while some of our new and ancillary products add to our revenues, they may carry smaller gross margins than our traditional balloon sinus dilation products, which also may hinder our path to profitability. As a result, we expect to continue to incur operating losses for the foreseeable future and may never achieve profitability. Furthermore, even if we do achieve profitability, we may be unable to sustain or increase profitability on an ongoing basis. If we do not achieve profitability, it will be more difficult for us to finance our business and accomplish our strategic objectives.

We may be unable to sustain our historical revenue growth.

Our revenue from sales of our sinus dilation balloon devices has grown in each of the fiscal years since we began commercialization in 2008. Historically, we have experienced significant revenue growth but we may not achieve similar growth rates in future periods. You should not rely on our operating results for any prior quarterly or annual period as an indication of our future operating performance. Our ability to increase our revenue in future periods at our historical growth rates, or at all, will depend primarily on our ability to increase sales of our sinus dilation balloon devices and other products, which, in turn, will depend in part on our success in growing our customer base and reorders from those customers. We may not be able to generate, sustain or increase revenue from our sinus dilation balloon devices or other products on a quarterly or annual basis. If we cannot achieve or sustain revenue growth for an extended period, our operating results may be adversely affected and our stock price may decline. In addition, a significant amount of our operating expenses are relatively fixed due to our manufacturing, research and development, and sales and general administrative efforts. Any failure to adjust spending quickly enough to compensate for a shortfall relative to our anticipated revenue could magnify the adverse impact of such shortfalls on our results of operations.

Pricing pressure from our competitors, customers and changes in third-party coverage and reimbursement may adversely affect demand for our products and negatively impact our operating results.

Competition in our industry has increased as a result of new market entrants, new technologies and as more established companies have intensified competitive pricing pressure. As a result of these competitive forces, we believe there will continue to be pricing pressure in the future. Because our products are generally purchased by ENT physician offices, ASCs and hospitals and billed to various third-party payors, changes in the purchasing behavior of such customers or the amount such payors are willing to reimburse our customers for procedures using our products, including as a result of healthcare reform initiatives, could create additional pricing pressure on us. In addition to these competitive forces, we continue to see pricing pressure as our customers introduce new pricing structures into their contracts and agreements, including fixed price formulas, capitated pricing and structured pricing intended to contain healthcare costs. Such trends may adversely affect demand for our products and may drive down the prices we are able to charge for our products, both of which would negatively affect our operating results.

If we are unable to achieve and maintain adequate levels of coverage or reimbursement for the procedures using our products, or any future products we may seek to commercialize, their commercial success may be severely hindered.

Hospital, physician and other healthcare provider customers, including ASC customers that purchase our products typically bill various third-party payors to cover all or a portion of the costs and fees associated with the procedures in which our products are used

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and bill patients for any deductibles or co-payments. In the hospital and ASC settings, our products are often used in a hybrid procedure in conjunction with traditional FESS. Because there is often no separate reimbursement for supplies used in surgical procedures, and with respect to FESS, no separate reimbursement for balloon sinus dilation, the additional cost associated with the use of our products in these settings can impact the profit margin of the hospital or surgery center where the hybrid procedure is performed. Some of our target customers may be unwilling to adopt our products in light of the additional associated cost. Further, any decline in the amount payors are willing to reimburse our customers for balloon sinus dilation procedures in either the office or facility setting could make it difficult for existing customers to continue using or to adopt our products and could create additional pricing pressure for us. Medicare has issued a final rule on the Hospital Outpatient Prospective Payment System, or OPPS, for 2017 which includes a reduction of payments for certain outpatient procedures performed in the hospital when FESS is performed on more than two sinuses. The result is to bundle payments for multi-sinus surgery regardless of the number of sinuses being treated. On average we expect most hospitals will experience a reduction in Centers for Medicare and Medicaid Services, or CMS, reimbursement because on average more than two sinuses are treated in a hospital sinus surgery procedure. As a result of this final rule, the portion of our business in which we sell to a hospital may suffer. If we are forced to lower the price we charge for our products, our gross margins will decrease, which will materially adversely affect our business.

Third-party payors, whether foreign or domestic, or governmental or commercial, are developing increasingly sophisticated methods of controlling healthcare costs. In addition, in the United States, no uniform policy of coverage and reimbursement for procedures using our products exists among third-party payors. Therefore, coverage and reimbursement for procedures using our products can differ significantly from payor to payor. In addition, payors continually review new and existing technologies for possible coverage and can, without notice, deny or reverse coverage or alter pre-authorization requirements for new or existing products and procedures. Additionally, some third-party payors do not currently cover or reimburse balloon sinus dilation procedures because they have determined insufficient evidence of favorable clinical outcomes is available. We are actively working to avoid or to reverse these non-coverage decisions, as applicable, but cannot provide assurance that we will be successful in these efforts.  If we are not successful in reversing existing non-coverage policies, or if third-party payors that currently cover or reimburse balloon sinus dilation procedures reverse or limit their coverage in the future, or if other third-party payors issue similar policies, this could have a material adverse impact on our business.

Further, we believe that future coverage and reimbursement may be subject to increased restrictions and payment reductions, such as additional preauthorization requirements, adoption by private health insurance companies of lower payments related to the 2017 CMS Hospital Outpatient Payment Rule converting Medicare patients undergoing FESS procedures performed in the hospital on more than two sinuses, transitioning hospital outpatient payments for FESS to comprehensive APCs per the 2017 CMS Hospital Outpatient Payment Rule thereby lowering average reimbursement levels for Medicare patients and tightening coverage criteria by Medicare. In addition, Medicare may further reduce reimbursement for procedures using our products when performed in the physician office setting or ASCs, which could cause the portion of our business in which we sell to physician offices and ASCs to suffer. In addition, commercial payors may use Medicare rates and/or coverage criteria as a reference for establishing their own payment rates and coverage criteria. Accordingly, any reduction in Medicare reimbursement rates or increase in coverage restrictions could result in lower commercial reimbursement for our products and tighter coverage requirements with commercial payors as well. Such changes in reimbursement or coverage could negatively impact our revenues and our business. Moreover, third-party coverage and reimbursement for procedures using our products or any of our products in development for which we may receive regulatory approval may not be available or adequate in either the United States or international markets, which could have an adverse impact on our business.

Aggregation of purchasing from collaboration and consolidation may lead to demands for price concessions or to the exclusion of some suppliers from certain market opportunities, which could have an adverse effect on our business, operating results or financial condition.

Because healthcare costs have risen significantly over the past decade, numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry to aggregate purchasing power. As the healthcare industry consolidates, competition to provide products and services to industry participants has intensified and may continue to do so. This in turn has resulted and will likely continue to result in greater pricing pressures or the exclusion of certain suppliers from certain market opportunities as group purchasing organizations, independent delivery networks and large single accounts continue to use their market power to consolidate purchasing decisions. In addition, such consolidation may lead these organizations to limit their number of suppliers. We expect that market demand, government regulation, third party coverage and reimbursement policies and societal pressures will continue to impact the healthcare industry, resulting in further business consolidations and alliances among our customers, which may exert further downward pressure on the prices of our products and may adversely impact our business, operating results or financial condition.

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Our revenue is primarily generated from our XprESS family of multi-sinus products; and, therefore, we are highly dependent on a limited number of products.

We began selling our XprESS family of products in 2010, and these products accounted for more than 80% of our revenue for the year ended December 31, 2016. Although we expect sales from new products to increase in future periods, we expect that sales of our XprESS family of products will continue to account for the substantial majority of our revenue for the foreseeable future. Therefore, our ability to execute our growth strategy and become profitable will depend not only upon a continued shift of more sinus procedures from traditional operating room settings to the ENT physician office setting, but also to the adoption of our XprESS family of products to perform those procedures. Some ENT physicians may have prior history with or preference for a competitor’s balloon sinus dilation products or be reluctant to alter practice patterns and undergo training required to use our products. If our XprESS products fail to achieve wide market acceptance for any reason, our business may be adversely affected.

If physicians or patients are not willing to change current practices or adopt office-based balloon sinus dilation procedures, our products may fail to gain increased market acceptance, and our business will suffer.

Our primary strategy to grow revenue is to drive an increase in office-based balloon sinus dilation procedures, the adoption of our XprESS family of products to perform these procedures and the use of our other related products. While the number of ENT physicians performing sinus procedures using office-based balloon sinus dilation has increased in recent years, there is a significant group of ENT physicians who have not yet adopted these procedures, and additional ENT physicians may not adopt office-based balloon sinus dilation for a number of reasons, including:

If additional ENT physicians do not continue to adopt, or existing ENT physicians cease using, office-based balloon sinus dilation procedures for any reason, including those listed above, our ability to execute our growth strategy would be impaired, and our business may be adversely impacted.

We believe recommendations and support of our products by notable ENT physicians can influence market acceptance and adoption. If we do not receive support from these influential ENT physicians, our ability to achieve broad market acceptance for our products may be impaired.

In addition, if patient receptivity toward treatment in an ENT physician office setting becomes less favorable in the future, this shift could negatively impact market acceptance of our products. Any negative change due to patient receptivity could also be compounded by patients reporting to physicians or other patients through word-of-mouth or social media.

Additionally, while it is currently more cost-effective to the healthcare system for providers to perform balloon sinus dilation in an ENT physician’s office than a FESS procedure in the operating room, healthcare economics are always subject to change. If the use of our balloon sinus dilation products were to cease being more cost-effective than FESS due to changes in reimbursement economics, our products may fail to gain market acceptance, our future growth would be limited and our business may be adversely affected. In addition, if payment rates for office-based balloon sinus dilation procedures were to be lowered, in particular by Medicare, would likely then cause other third-party payors to implement comparable reductions to their reimbursement rates, ENT physicians may reduce the frequency of balloon sinus dilation procedures and our business may be adversely affected.

We compete and may compete in the future against other companies, some of which have longer operating histories, more established products or greater resources than we do, which may prevent us from achieving increased market penetration or improved operating results.

Our industry is highly competitive, subject to change and significantly affected by new product introductions and other activities of industry participants. We believe competitors have historically dedicated and will continue to dedicate significant resources to promote their products or develop new products or methods to treat sinusitis. We currently compete against companies providing alternative treatments to balloon sinus dilation, as well as companies that provide competing balloon sinus dilation products, as well as other competing products. For example, the Xomed division of Medtronic sells a balloon sinus dilation device that competes with our XprESS family of products. Additionally, Intersect ENT is currently developing products for office-based treatment of sinusitis, which if approved may be competitive with us in the future. Many of the companies developing or marketing these ENT products are publicly traded or are divisions of publicly traded companies, including the Xomed division of Medtronic, the Acclarent division of

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Johnson & Johnson and the ArthroCare division of Smith & Nephew, each of which produces competing balloon sinus dilation products and other competing products, and the Gyrus ACMI division of Olympus, Stryker Corporation and Intersect ENT, each of which produces tools and devices for FESS. These companies may enjoy several competitive advantages over us, including:

To a lesser extent, we also have faced, and may in the future face, competition from pharmaceutical companies that develop medical therapies to treat sinusitis. In addition, substantially all of the products we manufacture are designed to be used exclusively during balloon sinus dilation or FESS procedures. If another company successfully develops an approach for the treatment of chronic sinusitis that would not benefit from the use of our products, or if another company develops a balloon sinus dilation device that is more efficacious, more cost-effective or easier to use than our products, sales of our products could be significantly and adversely affected, which could have a material adverse effect on our business and operating results.

Our business is substantially dependent on our license agreement with Acclarent, which exposes us to a variety of risks.

We are a party to a license agreement, or the Acclarent License, with Acclarent. Under the Acclarent License, Acclarent has granted us a non-exclusive license under patents held by Acclarent to manufacture, use and commercialize our XprESS, PathAssist and FinESS products and certain future versions of those products, or, collectively, the Covered Products. We have certain obligations under the Acclarent License, including paying Acclarent a royalty on the sale of Covered Products. If we fail to comply with our obligations under the Acclarent License, Acclarent may terminate the Acclarent License, in which case our current products would no longer enjoy a license under Acclarent’s patents. Without the license, Acclarent might successfully enforce its patents against us based on the sale of our current products, possibly resulting in our being ordered to pay Acclarent monetary damages and/or in our being enjoined from selling our current products within any country where Acclarent has a valid and enforceable claim covering a given product.  Furthermore, because the Acclarent License is non-exclusive, Acclarent could choose to also license the same intellectual property to other third-party competitors. Any of these outcomes could have a material adverse effect on our business.

In addition, we do not control the prosecution of the patent applications licensed to us under the Acclarent License. Therefore, these patents and applications may not be prosecuted or enforced in a manner consistent with the best interests of our business. If Acclarent fails to maintain the patents it has licensed to us under the Acclarent License, or loses its rights to those patents, the rights we have licensed may be reduced or eliminated, which could severely harm our ability to successfully commercialize our products.

Our long-term growth depends on our ability to continue to develop and commercialize additional ENT products.

The medical device industry is highly competitive and subject to rapid change and technological advancements. Therefore, it is important to our business that we continue to enhance our product offerings and introduce new products. Developing products is expensive and time-consuming and could divert management’s attention away from our core balloon sinus dilation business. However, if we are unsuccessful in developing and commercializing new products, our ability to increase our revenue may be impaired. Even if we are successful in developing additional products, the success of any new product offering or enhancements to existing products will depend on several factors, including our ability to:

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The launch of new products if not timed correctly and if not controlled properly may result in an adverse impact on sales of such new products, as well as sales of our core balloon sinus dilation products. In addition, our new products may not carry the same margins as our core balloon sinus dilation products, which adversely affected our gross margins during the second half of 2016 and could adversely affect our future gross margins.

Our future growth depends on physician awareness and adoption of our balloon sinus dilation devices and ancillary products.

We focus our sales, marketing and training efforts on ENT physicians. However, the initial point of contact for many patients suffering from chronic sinusitis may be primary care physicians or other referring medical professionals, such as nurse practitioners or physician assistants, who commonly see patients with sinus infections and sinusitis and prescribe pharmaceuticals to address sinusitis symptoms. We believe that education of primary care physicians and other medical professionals about the clinical merits and patient benefits of office-based balloon sinus dilation procedures is an important element of the growth of office-based balloon sinus dilation procedures. If we fail to educate primary care physicians and other medical professionals, they may not refer sinusitis patients to an ENT physician to perform balloon sinus dilation procedures and, as a result, those patients may continue to receive only medical management. If this were to occur, our ability to increase our revenue may be impaired.

Although efficacy of our products has been demonstrated in clinical studies sponsored by us, insurance companies who do not cover stand-alone balloon sinus dilation may require additional or independently performed clinical studies prior to adopting or covering or maintaining coverage of procedures in which our products are used as a stand-alone therapy.

Our success depends on the medical and third-party payor communities’ acceptance of our products as tools that are useful to ENT physicians treating patients with chronic sinusitis. We have sponsored one meta-data analysis and eight clinical studies with over 600 patients to track outcomes of treatment with our products. While the results of these studies, collectively indicate that our products can be used to successfully treat uncomplicated chronic sinusitis equally effectively as FESS while also providing better recovery outcomes, if physicians or insurers do not find our data compelling or wish to wait for additional or independently performed studies, they may choose not to use or provide coverage and reimbursement for our products. Currently, we estimate there are insurance plans, including a number of large third-party payors, covering approximately 75 million lives that have determined balloon sinus dilation to be investigational and therefore do not cover it at this time.

In addition, the long-term effects of balloon sinus dilation with our products beyond 24 months are not known. Certain ENT physicians, hospitals, ASCs and insurers may prefer to see longer-term efficacy data than we have produced. We cannot make any assurances that any data that we or others generate will be consistent with that observed in our existing clinical studies.

It is difficult to forecast future performance and our financial results may vary from forecasts and may fluctuate from quarter to quarter.

Our limited operating history and commercial experience make it difficult for us to predict future performance. A number of factors over which we have limited control, such as seasonal variations in revenue, may contribute to fluctuations in our financial results. In the first quarter, our results can be impacted by adverse weather and by resetting of annual patient healthcare insurance plan deductibles, both of which may cause patients to delay elective procedures in which our products are used. In the second quarter, demand may be increased by the seasonal nature of allergies and the resultant onset of sinus-related symptoms. In the third quarter, we believe the number of elective surgeries and particularly FESS or balloon sinus dilation procedures nationwide is historically lower than other quarters as a result of summer vacations of ENT physicians and their patients. In the fourth quarter, demand typically increases with the onset of the cold and flu season and related symptoms, as well as the desire of patients to spend the remaining balances in their flexible-spending accounts or because of lower out-of-pocket costs to patients who have already met their annual deductibles under their health insurance plans.

We have experienced and expect to continue to experience meaningful variability in our revenue and gross profit among quarters, as well as within each quarter, as a result of a number of factors, including, among others:

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Additionally, we typically receive orders and ship a significant amount of product toward the end of each quarter. If these orders or shipments get delayed, this could adversely affect our quarterly revenues.

In the event our actual revenue and operating results do not meet our forecasts or the forecasts or estimates of the research analysts that cover us for a particular period, the market price of our common stock may decline substantially.

We recently acquired and entered into an exclusive license for the XeroGel™ assets with CogENT Therapeutics, LLC. We may be unable to successfully integrate the manufacturing of XeroGel in a cost-effective and non-disruptive manner. In addition, acquisitions are risky and may harm our business and operating results.

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and advances in technologies. Accordingly, we have pursued and may continue to pursue acquisitions of, or joint ventures relating to, complementary businesses, products or technologies instead of developing them ourselves. Our ability to grow through acquisitions will depend, in part, on the availability of suitable candidates at acceptable prices, terms, and conditions; our ability to compete effectively for acquisition candidates; and the availability of capital and personnel to complete such acquisitions and run the acquired business effectively. We do not know if we will be able to successfully complete any future acquisitions or joint ventures. There are risks and uncertainties involved in this recent acquisition and any future acquisitions we may complete including:

In June 2016, we acquired and entered into an exclusive license for the XeroGel assets with CogENT Therapeutics, LLC. In connection with the acquisition, we became the manufacturer of XeroGel nasal packing material and will continue to market and sell XeroGel material to hospitals, offices and ASCs. We are in the process of transferring XeroGel manufacturing to our Plymouth facilities, which transfer may not be completed smoothly.

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Management has made certain assumptions related to the XeroGel acquisition including those related to projections of future revenue and the amount of goodwill and intangible assets purchased. While management has made these assumptions in good faith and believes them to be reasonable, the assumptions may turn out to be materially inaccurate, including for reasons beyond our control. If these assumptions are incorrect we may change or modify them, which could have an adverse effect on our financial condition or results of operations. Given the timing of the XeroGel acquisition, the estimated fair value of the net assets acquired as of June 30, 2016 was preliminary and subject to change. During the measurement period, we have recorded adjustments to the assets acquired. Intangible assets increased from $6.4 million to $10.2 million, excluding amortization, and goodwill decreased from $4.3 million to $0.5 million. We may continue to assess and refine the purchase price allocation through the end of the measurement period, which, in accordance with applicable accounting standards, should not exceed one year from the date of the XeroGel acquisition.

Additionally, we have recorded intangible assets, including goodwill, in connection with the XeroGel acquisition. On an ongoing basis, we will evaluate whether facts and circumstances indicate any impairment of the value of intangible assets. As circumstances change, we cannot assure you that the value of these intangible assets will be realized by us. If we determine that a significant impairment has occurred, we will be required to write-off the impaired portion of intangible assets, which could have an adverse effect on our results of operations in the period in which the write-off occurs.

Finally, some acquisitions may require the consent of the lender under our credit facility and we cannot predict whether the lender or future lenders would approve such acquisitions or the terms on which the lender would approve any such acquisitions. These and other risks could be heightened if we complete a large acquisition or multiple acquisitions within a relatively short period of time.

The size of the market for balloon sinus dilation products has not been established with precision, and may be smaller than we estimate.

Our estimate of the annual total addressable market for balloon sinus dilation products is based on a number of internal and third-party estimates, including, without limitation, the number of annual patient visits to ENT and primary care physicians, internal estimates regarding the number of certain types of FESS procedures performed annually, and our estimate of the number of people currently under medical management who would benefit from and be amenable to a balloon sinus procedure. In addition, our internal estimates are based in large part on current patterns of patient selection by ENT physicians for balloon sinus dilation. While we believe these factors have historically provided and may continue to provide us with effective tools in estimating the total market for balloon sinus dilation procedures and our products, these estimates may not be correct and the conditions supporting our estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors. As a result, our estimates of the annual total addressable market for our products may prove to be incorrect. If the actual number of patients who would benefit from our products and the annual total addressable market for our products is smaller than we have estimated, it may impair our sales growth and have an adverse impact on our business.

We have limited experience marketing and selling our products, and if we are unable to expand, manage, maintain and motivate our direct sales and marketing organizations we may not be able to generate anticipated revenue.

We began selling our first FDA-cleared product, FinESS, in April 2008. We subsequently began selling our XprESS in February 2010. As a result, we have limited experience marketing and selling our products. Our direct sales organization, including marketing and reimbursement has increased significantly over the past several years. Our operating results are directly dependent upon the sales and marketing efforts of our employees. If our direct sales force fails to adequately promote, market and sell our products, our sales may suffer.

We will need to retain and develop our direct sales personnel to build upon their expertise, tenure with our products and their relationships with customers. In order to generate future sales growth, we will need to expand the size and geographic scope of our direct sales organization. Accordingly, our future success will depend largely on our ability to continue to hire, train, retain and motivate skilled sales personnel with significant technical knowledge of sinus procedures and related products. Because the competition for their services is high, we cannot assure you we will be able to hire and retain additional personnel on favorable or commercially reasonable terms, if at all. Failure to hire or retain qualified sales personnel would prevent us from expanding our business and generating sales. If we are unable to expand our sales and marketing capabilities, we may not be able to effectively commercialize our products, which could have an adverse impact on our business.

In addition, in January 2017, we appointed a new Vice President, Sales. While we expect this management change to enhance the effectiveness of our sales organization, no assurance can be provided that it will or that it will not have an adverse effect on our sales organization and our future revenues.

We may be unable to manage our growth effectively.

Our past growth has provided, and our future growth may create, challenges to our organization. The number of our employees has increased significantly during the past several years. In the future, we expect to hire and train new personnel as we continue to

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grow and expand our operations. As a public company, we need to support managerial, operational, financial and other resources. This growth may place significant strain on us. Successful growth is also dependent upon our ability to implement appropriate financial and management controls and systems and procedures. If we fail to manage these challenges effectively, there may be an adverse impact on our business.

Our international third-party distributors may not effectively distribute our products.

We depend in part on medical device distributors and strategic relationships for the marketing and selling of our products outside of the United States and the United Kingdom. We depend on these distributors’ efforts to market our products, yet we are unable to control their efforts completely. In addition, we are unable to ensure that our distributors comply with all applicable laws regarding the sale of our products. If our distributors fail to effectively market and sell our products, and in full compliance with applicable laws, our operating results and business may suffer.  

Our ability to maintain our competitive position depends on our ability to attract and retain key executives and highly qualified personnel.

We believe that our continued success depends to a significant extent upon the efforts and abilities of our key executives and personnel, some of which have changed over the last year. For example, effective as of January 5, 2017, we have a new Vice President, Sales and a new General Counsel. Our Vice President, Reimbursement retired on December 31, 2016, and a new Vice President, Reimbursement is joining us on February 27, 2017. We also have a Chief Financial Officer who started with us in May 2016. As new and promoted employees gain experience in their roles, we could experience inefficiencies or lack of business continuity due to loss of historical knowledge and a lack of familiarity of new and promoted employees with business processes, operating requirements, policies and procedures. It is important to our success that these key executives quickly adapt to and excel in their new roles. If they are unable to do so, our business and financial results could be materially adversely affected. In addition, the loss of the services of any member of our senior management might significantly delay or prevent the achievement of our business objectives by diverting management’s attention to transition matters and identification of suitable replacements, if any, and could have a material adverse effect on our business. We do not maintain fixed term employment contracts with any of our employees. Each of our executives and key employees may terminate his or her employment with us at any time. The replacement of any of our key personnel likely would involve significant time and costs and may significantly delay or prevent the achievement of our business objectives and therefore could have an adverse impact on our business. In addition, we do not carry any “key person” insurance policies that could offset potential loss of service under applicable circumstances.

Many of our employees have become or will soon become vested in a substantial amount of our common stock or a number of common stock options. Our employees may be more likely to leave our company if the shares they own have significantly appreciated in value relative to the original purchase prices of the shares, or if the exercise prices of the options that they hold are significantly below the market price of our common stock. Our future success also depends on our ability to continue to attract and retain additional executive officers and other key employees.

We face the risk of product liability claims that could be expensive, divert management’s attention and harm our reputation and business. We may not be able to maintain adequate product liability insurance.

Our business exposes us to the risk of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices. This risk exists even if a device is cleared or approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA or an applicable foreign regulatory authority. Our products are designed to affect, and any future products will be designed to affect, important bodily functions and processes. Any side effects, manufacturing defects, misuse or abuse associated with our products or our products in development could result in patient injury or death. The medical device industry has historically been subject to extensive litigation over product liability claims, and we cannot offer any assurance that we will not face product liability suits. We may be subject to product liability claims if our balloon sinus dilation or other products cause, or merely appear to have caused, patient injury or death. In addition, an injury that is caused by the activities of our suppliers, such as those who provide us with components and raw materials, may be the basis for a claim against us. Product liability claims may be brought against us by consumers, healthcare providers or others selling or otherwise coming into contact with our products, among others. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities and reputational harm. In addition, regardless of merit or eventual outcome, product liability claims may result in:

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While we may attempt to manage our product liability exposure by proactively recalling or withdrawing from the market any defective products, any recall or market withdrawal of our products may delay the supply of those products to our customers and may impact our reputation. We can provide no assurance that we will be successful in initiating an appropriate market recall or market withdrawal efforts that may be required in the future or that these efforts will have the intended effect of preventing product malfunctions and the accompanying product liability that may result. Such recalls and withdrawals may also be used by our competitors to harm our reputation for safety or be perceived by physicians or patients as a safety risk when considering the use of our products, either of which could have an adverse impact on our business.

In addition, although we have product liability and clinical study liability insurance that we believe is appropriate, this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost or on acceptable terms or otherwise protect against potential product liability claims, we could be exposed to significant liabilities. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have an adverse impact on our business.

We utilize third-party, single-source suppliers for some components and materials used in our products, and the loss of any of these suppliers could have an adverse impact on our business.

We rely on single-source suppliers for some components and materials used in our products. Our ability to supply our products commercially and to develop any future products depends, in part, on our ability to obtain these components in accordance with regulatory requirements and in sufficient quantities for commercialization and clinical testing. While our suppliers have generally met our demand for their products on a timely basis in the past, we cannot assure that they will in the future be able to meet our demand for their products, either because we do not have long-term agreements with those suppliers, our relative importance as a customer to those suppliers, or their ability to produce the components used in our products.

While we believe replacement suppliers exist for all components and materials we obtain from single sources, establishing additional or replacement suppliers for any of these components or materials, if required, may not be accomplished quickly. Even if we are able to find a replacement supplier, the replacement supplier would need to be qualified and may require additional regulatory authority approval, which could result in further delay. While we seek to maintain adequate inventory of the single-source components and materials used in our products in the event of disruption, those inventories may not be sufficient.

If our third-party suppliers fail to deliver the required commercial quantities of materials on a timely basis and at commercially reasonable prices, and we are unable to find one or more replacement suppliers capable of production at a substantially equivalent cost in substantially equivalent volumes and quality on a timely basis, the continued commercialization of our products, the supply of our products to customers and the development of any future products would be delayed, limited or prevented, which could have an adverse impact on our business.

If the quality of our products does not meet the expectations of ENT physicians or patients, then our brand and reputation could suffer and our business could be adversely impacted.

In the course of conducting our business, we must adequately address quality issues that may arise with our products, as well as defects in third-party components included in our products. Although we have established internal procedures to minimize risks that may arise from quality issues, there can be no assurance that we will be able to eliminate or mitigate occurrences of these issues and associated liabilities. If the quality of our products does not meet the expectations of ENT physicians or patients, then our brand and reputation could suffer with those ENT physicians or patients and our business could be adversely impacted.

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We have limited prior experience selling our products outside of the United States and do not know if we will be successful in achieving adoption of our products and revenue growth outside of the United States in a timely manner. A variety of risks associated with international operations could materially adversely affect our business.

We established a subsidiary in the United Kingdom in 2015 and have been selling our products in certain European and other countries using a combination of direct sales representatives and a network of independent distributors. We now market our products in over 10 countries outside the United States. Although our international sales comprised less than 10 percent of our revenues during 2016, they may increase and comprise a greater portion in future periods. Our international sales and operations potentially subject us to a number of risks, including:

Furthermore, in June 2016, the United Kingdom held a referendum in which voters approved an exit from the European Union, commonly referred to as “Brexit.” As a result of the referendum, negotiations are expected to determine the future terms of the United Kingdom’s relationship with the European Union, including the terms of trade between the United Kingdom and the European Union. Although it is unknown what those terms will be, it is possible that there will be greater restrictions on the movement of goods and

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people between the United Kingdom and European Union countries and increased regulatory complexities, which could affect our ability to sell our products in certain European Union countries through our subsidiary in the United Kingdom. Brexit could adversely affect European and worldwide economic and market conditions and could contribute to instability in global financial and foreign exchange markets, including volatility in the value of the British pound and Euro. In addition, other European countries may seek to conduct referenda with respect to continuing membership with the European Union. We do not know to what extent these changes will impact our business. These possible effects of Brexit, and others that we cannot anticipate, could adversely affect our business, operations and financial results.

We maintain policies, procedures and internal controls designed to promote compliance with the FCPA, OFAC restrictions and other anti-corruption and anti-money laundering laws, as well as export control laws, customs laws, sanctions laws and other laws. We plan to regularly evaluate these policies and to enhance them as our international business develops and expands. If we, our business partners, distributors or intermediaries fail to comply with the requirements of the FCPA, OFAC restrictions or similar laws of other countries, or our controls and procedures fail to detect such noncompliance, governmental authorities in the United States or elsewhere, as applicable, could seek to impose civil penalties, criminal fines, and other collateral consequences.

Most of our product sales are currently denominated in U.S. dollars. However, with our subsidiary in the United Kingdom and increasing operations in non-U.S. jurisdictions, fluctuations in the value of the U.S. dollar relative to foreign currencies have recently impacted and in the future could adversely impact our operating results. In addition, such fluctuations could decrease demand for our products. For example, if the value of the U.S. dollar increases relative to the British Pound Sterling and Euro or other foreign currencies in which we transact business, our products could become more costly to the international customers and therefore less competitive in international markets. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. The volatility of exchange rates depends on many factors that we cannot forecast with reliable accuracy. Fluctuations in currency exchange rates could have an adverse impact on our financial results in the future.

Failure to comply with anti-bribery, anti-corruption, and anti-money laundering laws, including the FCPA and similar laws associated with our activities outside of the United States could subject us to penalties and other adverse consequences.

We are subject to the FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the USA PATRIOT Act, the United Kingdom Bribery Act of 2010 and other anti-corruption, anti-bribery and anti-money laundering laws around the world where we conduct activities and sell our products. We face significant risks and liability if we fail to comply with the FCPA and other anti-corruption and anti-bribery laws that prohibit companies and their employees and third-party business partners, such as distributors or resellers, from authorizing, offering or providing, directly or indirectly, improper payments or benefits to foreign government officials, political parties or candidates, employees of public international organizations including healthcare professionals, or private-sector recipients for the corrupt purpose of obtaining or retaining business, directing business to any person, or securing any advantage.

We leverage various third parties to sell our products and conduct our business abroad. We, our distributors and channel partners, and our other third-party intermediaries may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities (such as in the context of obtaining government approvals, registrations, or licenses) and may be held liable for the corrupt or other illegal activities of these third-party business partners and intermediaries, our employees, representatives, contractors, partners, and agents, even if we do not explicitly authorize such activities. In many foreign countries, particularly in countries with developing economies, it may be a local custom that businesses engage in practices that are prohibited by the FCPA or other applicable laws and regulations. As such, we intend to continue to implement an FCPA/anti-corruption compliance program to ensure compliance with such laws but cannot assure you that all of our employees and agents, as well as those companies to which we outsource certain of our business operations, will not take actions in violation of our policies and applicable law, for which we may be ultimately held responsible.

Any violation of the FCPA, other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower, adverse media coverage, investigations, loss of export privileges, severe criminal or civil sanctions and, in the case of the FCPA, suspension or debarment from U.S. government contracts, which could have a material and adverse effect on our reputation, business, operating results and prospects. In addition, responding to any enforcement action or related investigation may result in a materially significant diversion of management’s attention and resources and significant defense costs and other professional fees.

If we fail to comply with U.S. export control and economic sanctions or fail to expand and maintain an effective sales force or successfully develop our international distribution network, our business, financial condition and operating results may be adversely affected.

We currently derive a substantial portion of our revenue from sales generated from our own predominantly U.S. but to a lesser extent our U.K. direct sales force. Failure to maintain or expand our direct sales force could adversely impact our financial and operating performance. Additionally, we use international distributors in certain foreign countries to augment our sales efforts. We cannot provide assurance that we will be able to successfully develop our relationships with third-party distributors internationally. In

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addition, we are subject to U.S. export control and economic sanctions laws relating to the sale of our products, the violation of which could result in substantial penalties being imposed against us. More broadly, if we fail to comply with export control laws or successfully develop our relationship with international distributors, our sales could fail to grow or could decline, and our ability to grow our business could be adversely affected. Distributors that are in the business of selling other medical products may not devote a sufficient level of resources and support required to generate awareness of our products and grow or maintain product sales. If our distributors are unwilling or unable to market and sell our products, or if they do not perform to our expectations, we could experience delayed or reduced market acceptance and sales of our products.

Failure of a key information technology system, process or site could have an adverse impact on our business.

We rely extensively on information technology systems to conduct business. These systems impact, among other things, ordering and managing materials from suppliers, shipping products to customers, processing transactions, summarizing and reporting results of operations, complying with regulatory, legal or tax requirements, data security and other processes necessary to manage our business. If our systems are damaged or cease to function properly due to any number of causes, ranging from catastrophic events to power outages to security breaches, and our business continuity plans do not effectively compensate on a timely basis, we may suffer interruptions in our operations, which could have an adverse impact on our business. In addition, in 2015, we implemented a new enterprise resource planning system designed to integrate our operations, including supply-chain, order entry, manufacturing, inventory and financial reporting, among others. Our experience with this system is still limited. If the system does not continue to perform in the manner expected, our business, including our ability to report financial results accurately and timely, could be adversely affected. Furthermore, if a security breach occurs, and our proprietary information, or the information of patients using our products, is disclosed or misused, then we could be affected by the imposition of regulatory sanctions or fines, the incurring of expenses resulting from a data privacy breach, an increase in operating expenses, or the occurrence of other adverse consequences to our business.

In addition, we accept payments for many of our sales through credit and debit card transactions, which are handled through a third-party payment processor. As a result, we are subject to a number of risks related to credit and debit card payments. As a result of these transactions, we pay interchange and other fees, which may increase over time and could require us to either increase the prices we charge for our products or experience an increase in our costs and expenses. In addition, as part of the payment processing process, we transmit our customers’ credit and debit card information to our third-party payment processor. We may in the future become subject to lawsuits or other proceedings for purportedly fraudulent transactions arising out of the actual or alleged theft of our customers’ credit or debit card information if the security of our third-party credit card payment processor is breached. We and our third-party credit card payment processor are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we or our third-party credit card payment processor fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, and there may be an adverse impact on our business.

If our facilities are damaged or become inoperable, we will be unable to continue to research, develop and manufacture our products and, as a result, there will be an adverse impact on our business until we are able to secure a new facility.

We do not have redundant facilities. We perform substantially all of our research and development, manufacturing and back office activity and maintain substantially all our raw material and finished goods inventory in a single location in Plymouth, Minnesota, although XeroGel nasal packing material continues to be manufactured in Hayward, California. Our facilities and equipment would be costly to replace and could require substantial lead time to repair or replace. The facilities may be harmed or rendered inoperable by natural or man-made disasters, including, but not limited to, tornadoes, flooding, fire and power outages, which may render it difficult or impossible for us to perform our research, development, manufacturing and commercialization activities for some period of time. The inability to perform those activities, combined with our limited inventory of reserve raw materials and finished product, may result in the inability to continue manufacturing our products during such periods and the loss of customers or harm to our reputation. Although we possess insurance for damage to our property and the disruption of our business, this insurance may not be sufficient to cover all of our potential losses and this insurance may not continue to be available to us on acceptable terms, or at all.

Our total assets include substantial amounts of goodwill and intangible assets and an impairment of our goodwill or intangible assets could adversely affect our results of operations.

Goodwill and intangible assets represented approximately 14% of our total assets as of December 31, 2016. We evaluate our goodwill for impairment on an annual basis or at other times during the year if events or circumstances indicate that it is more likely than not that the fair value is below the carrying value. We evaluate intangible assets for impairment when facts or circumstances suggest that the carrying value of these assets may not be recoverable. Our evaluation of impairment requires us to make certain estimates and assumptions including projections of future results. Such estimates and assumptions may not prove to be accurate in the future. After performing our evaluation for impairment, including an analysis to determine the recoverability of intangible assets, we

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will record a noncash impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. If these impairment losses are significant, our operating results could be adversely affected.

Risks Relating to Government Regulation

We received a Form 483 from the FDA. This could lead to a warning letter, which could have a material adverse effect on our business.

In September 2016, following an inspection of certain documentation relating to our prospective, multi-center study of children with chronic rhinosinusitis treated with the XprESS™ Multi-Sinus Dilation System, the FDA issued a Form 483, List of Inspectional Observations, containing two observations. The first observation relates to not obtaining FDA and IRB approval for changes to an investigational plan and the second observation relates to not ensuring prompt compliance with the study protocol by clinical investigators. These observations relate to study deviations which occurred when some physicians decided to treat sinuses outside of the scope of the study protocol due to medical necessity thereby avoiding the need for a follow-on procedure. Following our receipt of the Form 483, we implemented and completed corrective and preventive actions to fully address the FDA observations, and we provided written responses to the FDA detailing these corrective and preventive actions completed. The outcome of this matter is presently uncertain. We cannot assure that the FDA will conclude that our corrective and preventive actions are adequate to address the observations. If the FDA is not satisfied, it may issue a warning letter to us, which could have a material adverse effect on our business.

The FDA regulatory clearance process is expensive, time-consuming and uncertain, and the failure to obtain and maintain required regulatory clearances and approvals could prevent us from commercializing our products.

Before we can market or sell a new regulated product or a new use of or a claim for a cleared product in the United States, we must obtain clearance from the FDA through the 510(k) premarket notification process, unless an exemption applies. In addition, we may be required to seek FDA clearance for any changes or modifications to our products that could significantly affect their safety or effectiveness, or would constitute a change in intended use. The FDA requires every manufacturer to make the determination regarding the need for a new 510(k) submission in the first instance, but the FDA may review the manufacturer’s decisions not to seek a new 510(k). We may make changes to our 510(k)-cleared products without seeking additional clearances or approvals if we believe such clearances or approvals are not necessary. However, the FDA may disagree with this determination and require that we obtain new clearances or approvals for modifications, in which case we may be required to recall and stop marketing our products as modified, which could require us to redesign our products, conduct clinical trials to support any modifications, and pay significant regulatory fines or penalties. In addition, the FDA may not approve or clear our products for the indications that are necessary or desirable for successful commercialization or could require clinical trials to support any modifications.

The 510(k) clearance processes can be expensive, time-consuming and uncertain. In addition to the time required to conduct clinical trials, if necessary, it generally takes from three to six months from submission of an application to obtain 510(k) clearance; however, it may take longer and 510(k) clearance may never be obtained. Our ability to obtain additional regulatory clearances for new products and indications may be significantly delayed or may never be obtained. Moreover, any new product introduction or product modification could be subjected to the lengthier, more rigorous FDA premarketing process.

Delays in receipt of, or failure to obtain, regulatory clearances for any product enhancements or new products we develop would result in delayed or no realization of revenue from such product enhancements or new products and in substantial additional costs which could decrease our profitability.

Further, the FDA may change its clearance and approval policies, adopt additional regulations or revise existing regulations, or take other actions which may prevent or delay approval or clearance of our products under development or impact our ability to modify our currently cleared products on a timely basis. For example, in response to industry and healthcare provider concerns regarding the predictability, consistency and rigor of the 510(k) regulatory pathway, the FDA initiated an evaluation of the program, and in January 2011, announced several proposed actions intended to reform the review process governing the clearance of medical devices. The FDA intends these reform actions to improve the efficiency and transparency of the clearance process, as well as bolster patient safety. In addition, as part of the Food and Drug Administration Safety and Innovation Act, Congress reauthorized the Medical Device User Fee Amendments with various FDA performance goal commitments and enacted several “Medical Device Regulatory Improvements” and miscellaneous reforms which are further intended to clarify and improve medical device regulation both pre- and post-clearance or approval.

In addition, we are required to continue to comply with applicable FDA and other regulatory requirements once we have obtained clearance for a product. We cannot assure you that we will successfully maintain the clearances we have received or may receive in the future. In addition, our existing clearances can be revoked if any issues arise that bring into question our products’ safety or effectiveness. Any failure to maintain compliance with FDA regulatory requirements could have an adverse impact on our business.

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The misuse or off-label use of our products may harm our image in the marketplace, result in injuries that lead to product liability suits or result in costly investigations, fines or sanctions by regulatory bodies if we are deemed to have engaged in the promotion of these uses, any of which could be costly to our business.

The products we currently market have been cleared by the FDA for specific indications. We train our marketing and direct sales force to not promote our products for uses outside of the FDA-cleared indications for use, known as “off-label uses.” We cannot, however, prevent a physician from using our products off-label, when in the physician’s independent professional medical judgment he or she deems it appropriate. There may be increased risk of injury to patients if physicians attempt to use our products off-label. Furthermore, the use of our products for indications other than those cleared by the FDA or approved by any foreign regulatory body may not effectively treat such conditions, which could harm our reputation in the marketplace among physicians and patients.

If the FDA or any foreign regulatory body determines that our promotional materials or training constitute promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our business activities to constitute promotion of an off-label use, which could result in significant penalties, including, but not limited to, criminal, civil and administrative penalties, damages, fines, disgorgement, exclusion from participation in government healthcare programs, and the curtailment of our operations.

In addition, physicians may misuse our products or use improper techniques if they are not adequately trained, potentially leading to injury and an increased risk of product liability. If our products are misused or used with improper technique, we may become subject to costly litigation by our customers or their patients. Similarly, in an effort to decrease costs, physicians may also reuse those of our products that are intended for a single use or may purchase reprocessed products from third-party reprocessors in lieu of purchasing new products from us, which could result in product failure and liability. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizeable damage awards against us that may not be covered by insurance.

Our products may cause or contribute to adverse medical events that we are required to report to the FDA, and if we fail to do so, we would be subject to sanctions that would materially harm our business.

Our marketed products are subject to Medical Device Reporting, or MDR, obligations, which require that we report to the FDA any incident in which our products may have caused or contributed to a death or serious injury, or in which our products malfunctioned and, if the malfunction were to recur, it could likely cause or contribute to a death or serious injury. The timing of our obligation to report under the MDR regulations is triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events of which we become aware within the prescribed timeframe. We may also fail to recognize that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the use of our products. If we fail to comply with our reporting obligations, the FDA could take action including warning letters, untitled letters, administrative actions, criminal prosecution, imposition of civil monetary penalties, revocation of our device clearances, seizure of our products, or delay in clearance of future products.

We and any of our contract manufacturers are subject to various governmental regulations related to the manufacturing of our products, and we may incur significant expenses to comply with, experience delays in our product commercialization as a result of, and be subject to material sanctions if we or our contract manufacturers violate, these regulations.

The methods used in, and the facilities used for, the manufacture of our products must comply with the FDA’s QSR which covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of medical devices. The FDA enforces the QSR through periodic announced or unannounced inspections of manufacturing facilities, and both we and any contract manufacturers are subject to such inspections. We cannot guarantee that we or any third-party manufacturers will take the necessary steps to comply with applicable regulations, which could cause delays in the delivery of our products.

Failure to comply with applicable FDA requirements, or later discovery of previously unknown problems with our products or our third-party manufacturers’ manufacturing processes, including any failure to take satisfactory corrective action in response to an adverse QSR inspection, can result in, among other things:

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Any of these actions could prevent us from marketing, distributing or selling our products and would likely harm our business.

Outside of the United States, our devices must comply with the laws and regulations of the foreign countries in which they are marketed, and compliance may be costly and time-consuming. Failure to obtain and maintain regulatory approvals in jurisdictions outside the United States will prevent us from marketing our products in such jurisdictions.

We currently market, and intends to continue to market, our products in Europe. To market our products in the Member States of the European Economic Area, the EEA, our devices are required to comply with the essential requirements of the EU Medical Devices Directives (Council Directive 93/42/EEC of 14 June 1993 concerning medical devices, as amended). Compliance with these requirements entitles us to affix the CE conformity mark to our medical devices, without which they cannot be commercialized in the EEA. In order to demonstrate compliance with the essential requirements and obtain the right to affix the CE conformity mark, we must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Except for low-risk medical devices (Class I non‑sterile, non‑measuring devices), where the manufacturer can issue an EC Declaration of Conformity based on a self-assessment of the conformity of its products with the essential requirements of the Medical Devices Directives, a conformity assessment procedure requires the intervention of a Notified Body, which is an organization accredited by a Member State of the EEA, to conduct conformity assessments. The Notified Body would typically audit and examine the quality system for the manufacture, design and final inspection of our devices before issuing a certification demonstrating compliance with the essential requirements. Based on this certification, we can draw up an EC Declaration of Conformity, which allows us to affix the CE mark to our products.

In September 2012, the European Commission published proposals for the revision of the E.U. regulatory framework for medical devices. The proposal would replace the Medical Devices Directive with a new regulation (the “Medical Devices Regulation”). In April 2014, the European Parliament approved a package of reforms to the European Commission's proposals. In September 2015, the European Council published responses to the European Parliament’s proposed reforms. In June 2016 European lawmakers published a draft version of the Medical Devices Regulation, consolidating the various proposed regulations into a single document. Unlike the Directives that must be implemented into national laws, the Medical Devices Regulation would be directly applicable in all EEA Member States and so is intended to eliminate current national differences in regulation of medical devices. Under the draft version of the Medical Devices Regulation, only designated “special notified bodies” would be entitled to conduct conformity assessments of high-risk devices. These special notified bodies will need to notify the European Commission when they receive an application for a conformity assessment for a new high-risk device. The European Commission will then forward the notification and the accompanying documents on the device to the Medical Devices Coordination Group, a new, yet to be created body chaired by the European Commission and consisting of representatives of Member States, for an opinion.

If adopted, the Medical Devices Regulation is expected to apply three years after its formal adoption, which is anticipated to occur in 2017. In its current draft form, the Medical Devices Regulation would, among other things, also impose additional reporting requirements on manufacturers of high risk medical devices, impose an obligation on manufacturers to appoint a “qualified person” responsible for regulatory compliance, and provide for stricter clinical evidence requirements. However, these new rules and procedures may result in increased regulatory oversight of any future high-risk devices that Entellus may develop and this may, in turn, increase the costs, time and requirements that need to be met in order to maintain or place such devices on the EEA market. We do not know when or if the Medical Devices Regulation will be adopted or what exact requirements will be imposed on us if adopted. However, additional or more stringent approval requirements imposed by the Medical Devices Regulation could cause us to fail to obtain or maintain regulatory approvals, certifications or registrations in the EEA which would adversely impact our business, financial condition and operating results.

We may not be able to obtain regulatory approvals or certifications outside the United States on a timely basis, if at all. Clearance or approval by the FDA does not ensure approval or certification by regulatory authorities or Notified Bodies in other countries, and approval or certification by one foreign regulatory authority or Notified Body does not ensure approval by regulatory authorities in other countries or by the FDA. We may be required to perform additional pre-clinical or clinical studies even if the FDA clearance or approval, or the right to bear the CE mark, has been obtained. If we fail to obtain or maintain regulatory approvals, certifications or registrations in any foreign country in which we plan to market our products, our business, financial condition and operating results could be adversely affected.

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Our products may in the future be subject to product recalls. A recall of our products, either voluntarily or at the direction of the FDA or another governmental authority, or the discovery of serious safety issues with our products, could have a significant adverse impact on us.

The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in their design or manufacture. The FDA’s authority to require a recall must be based on a finding that there is reasonable probability that the device would cause serious injury or death. We may also choose to voluntarily recall a product if any material deficiency is found. A government-mandated or voluntary recall could occur as a result of an unacceptable risk to health, component failures, malfunctions, manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our reputation and business, which could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be subject to liability claims, be required to bear other costs, or take other actions that may have a negative impact on our future sales and our ability to generate profits.

Depending on the corrective action we take to redress a product’s deficiencies or defects, the FDA may require, or we may decide, that we will need to obtain new approvals or clearances for the device before we may market or distribute the corrected device.  Seeking such approvals or clearances may delay our ability to replace the recalled devices in a timely manner. Moreover, if we do not adequately address problems associated with our devices, we may face additional regulatory enforcement action, including FDA warning letters, product seizure, injunctions, administrative penalties, or civil or criminal fines.

Companies are required to maintain certain records of recalls and corrections, even if they are not reportable to the FDA. We may initiate voluntary recalls or corrections for our products in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, they could require us to report those actions as recalls and we may be subject to enforcement action.

If clinical studies of our future products do not produce results necessary to support regulatory clearance or approval in the United States or, with respect to our current or future products, elsewhere, we will be unable to expand the indications for or commercialize these products.

We are currently conducting a Eustachian tube study to support a 510(k) clearance for a new indication for our balloon sinus dilation products. In addition, we will likely need to conduct additional clinical studies in the future to support clearance for new indications for our existing products or new product lines, or for the approval of the use of our products in some foreign countries. Clinical testing can take many years, can be expensive and carries uncertain outcomes. The initiation and completion of any of these studies may be prevented, delayed, or halted for numerous reasons.

Clinical failure can occur at any stage of testing. Our clinical studies may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical and non-clinical testing in addition to those we have planned. Our failure to adequately demonstrate the safety and efficacy of any of our devices would prevent receipt of regulatory clearance or approval and, ultimately, the commercialization of that device or indication for use. Even if our future products are cleared in the United States, commercialization of our products in foreign countries would require approval by regulatory authorities in those countries. Approval procedures vary among jurisdictions and can involve requirements and administrative review periods different from, and greater than, those in the United States, including additional preclinical studies or clinical trials. Any of these occurrences could have an adverse impact on our business.

Healthcare regulatory reform may affect our ability to sell our products profitably.

In the United States and in certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the regulatory and healthcare systems in ways that could impact our ability to sell our products profitably. In the United States in recent years, new legislation has been proposed and adopted at the federal and state levels that is effecting major changes in the healthcare system. In addition, new regulations and interpretations of existing healthcare statutes and regulations are frequently adopted and cannot be predicted.  

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In March 2010, the Affordable Care Act was signed into law. One of the goals of the healthcare reform of the Affordable Care Act was to expand coverage to more individuals. However the Affordable Care Act and other reform legislation increase government price controls, impose additional regulatory mandates and involve other measures designed to constrain medical costs. The Affordable Care Act substantially changes the way healthcare is financed by both governmental and private insurers, encourages improvements in the quality of healthcare items and services and significantly impacts the medical device industry. Among other things, the Affordable Care Act:

The results of the 2016 United States presidential and congressional elections may create regulatory uncertainty, including with respect to the United States government’s role, in the United States healthcare industry. As a result of such elections, there are renewed and reinvigorated calls for the repeal and replacement of all or parts of the Affordable Care Act. Any such repeal, replacement or material modification of the Affordable Care Act could cause significant uncertainty in the U.S. healthcare market, could increase our costs, decrease our revenues or inhibit our ability to sell our products. We cannot predict with certainty what impact any United States federal and state health reforms will have on us, but such changes could impose new and/or more stringent regulatory requirements on our activities or result in reduced reimbursement for our products, any of which could adversely impact our business and/or revenues.

In addition, third-party payors regularly update payments to physicians and hospitals where our products are used. For Medicare, annual updates to physician payments are made using a prescribed statutory formula. In the past, when the application of the formula resulted in lower payment, Congress has passed interim legislation to prevent the reductions. However, the Medicare Access and CHIP Reauthorization Act of 2015, or MACRA, ended the use of the statutory formula, and provided for a 0.5% annual increase in payment rates under the Medicare Physician Fee Schedule through 2019, but no annual update from 2020 through 2025. MACRA also introduced a merit based incentive bonus program for Medicare physicians beginning in 2019. At this time it is unclear how the introduction of the merit based incentive program will impact overall physician reimbursement under the Medicare program. In addition, the Budget Control Act of 2011 imposed reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, due to subsequent legislative amendments, will stay in effect through 2025 unless additional Congressional action is taken. These and other payment updates could directly impact the demand for our products or any products we may develop in the future, if cleared or approved.

Furthermore, we believe that many individuals who have obtained insurance coverage through the health insurance exchanges which arose as a result of the Affordable Care Act have done so with policies that have significantly higher deductibles than policies they may have obtained prior to its enactment. Because the out-of-pocket costs of undergoing a procedure such as balloon sinus dilation for patients who have not met their deductible for a given year would be significantly higher than they historically would have been, these patients may be discouraged from undergoing such a procedure due to the cost. Any reluctance on the part of patients to undergo procedures utilizing our products due to cost could impact our ability to expand sales of our products and could adversely impact our business.

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We are subject to additional federal, state and foreign laws and regulations relating to our healthcare business; our failure to comply with those laws could have an adverse impact on our business.

Although we do not provide healthcare services, submit claims for third-party reimbursement, or receive payments directly from Medicare, Medicaid or other third-party payors for our products, because our products are or may be covered by insurance plans, including, without limitation, federal and state funded health care programs, we are subject to healthcare fraud and abuse regulation and enforcement by federal and state governments, which could adversely impact our business. U.S. healthcare fraud and abuse and health information privacy and security laws potentially applicable to our operations include:

The risk of our being found in violation of these laws and regulations is increased by the fact that many of them are highly technical in nature and have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. We are unable to predict what additional federal or state legislation or regulatory initiatives may be enacted in the future regarding our business or the healthcare industry in general, or what effect such legislation or regulations may have on us. Federal or state governments may impose additional restrictions or adopt interpretations of existing laws that could have a material adverse effect on us.

Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under such laws, it is possible that some of our business activities, including, without limitation, certain sales and marketing practices and financial arrangements, including the provision of stock options as partial compensation for consulting services, with physicians, some of whom use or purchase our products, and other customers, could be subject to challenge under one or more of such laws. Any investigation of us or action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal

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expenses and divert our management’s attention from the operation of our business. If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from participation in governmental healthcare programs, disgorgement, contractual damages, reputational harm, diminished profits and future earnings, and the curtailment or restructuring of our operations, any of which could adversely impact our business.

We may be subject to, or become subject to, in the future, foreign laws and regulations imposing obligations on how we collect, store and process personal information. Our actual or perceived failure to comply with such obligations could harm our business. Ensuring compliance with such laws could also impair our efforts to maintain and expand our customer base, and thereby decrease our revenue.

In the conduct of our business, we may at times process personal data. The U.S. federal government and various states have adopted or proposed guidelines or rules for the collection, distribution, use and storage of personal information of individuals. The European Union also has laws and regulations dealing with the collection and use of personal data obtained from their residents, which are often more restrictive than those in the United States and which restrict transfers of data to the United States unless certain requirements are met. We have operations in the United Kingdom that may subject to these rules. These obligations may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other requirements or our practices. In addition, these rules are constantly changing. For example, following a decision of the European Court of Justice in October 2015, transferring personal data to U.S. companies that had certified as member of the U.S. Safe Harbor Scheme was declared invalid and the other methods to permit transfer are now under review.

Any failure or perceived failure by us to comply with privacy or security laws, policies, legal obligations or industry standards or any security incident that results in the unauthorized release or transfer of personally identifiable information may result in governmental enforcement actions and investigations including by European Data Protection Authorities, fines and penalties, litigation and/or adverse publicity, including by consumer advocacy groups, and could cause our customers, healthcare professional and their patients to lose trust in us, which could have an adverse effect on our reputation and business. Such failures could have a material adverse effect on our financial condition and operations. If the third parties we work with violate applicable laws, contractual obligations or suffer a security breach, such violations may also put us in breach of our obligation under privacy laws and regulation and/or could in turn have a material adverse effect on our business.

The laws in the European Union are under reform and from 2018 onwards, we will be subject to the requirements of the General Data Protection Regulation because we are processing data in the European Union and/or offering goods to residents of the European Union. The General Data Protection Regulation is expected to come into force in early 2018. It increases the deadline for data breach notifications, imposes additional obligations when we contract with service providers and increases administrative burdens on companies processing personal data. If we do not comply with our obligations under the Regulation they could be exposed to significant fines of up to 20,000,000 Euros or up to 4% of the total worldwide annual turnover of the preceding financial year, whichever is higher.

We may be unable to obtain or maintain international regulatory registrations or approvals for our current or future products and indications, which could adversely impact our business.

Sales of our devices outside the United States are subject to foreign regulatory requirements that vary widely from country to country. In addition, the FDA regulates exports of medical devices from the United States. Complying with international regulatory requirements can be an expensive and time-consuming process and approval is not certain. The time required to obtain registration or approvals, if required by other countries, may be longer than that required for FDA clearance, and requirements for such registrations or approvals may significantly differ from FDA requirements. In certain countries we intend to rely upon third-party distributors to obtain all required regulatory registrations and approvals, and these distributors may be unable to obtain or maintain such registrations or approvals. Our distributors in these countries may also incur significant costs in attempting to obtain and in maintaining foreign regulatory approvals or registrations, which could increase the difficulty of attracting and retaining qualified distributors. If these distributors experience delays in receiving necessary registrations or approvals to market our products outside the United States, or if they fail to receive those registrations or approvals, we may be unable to market our products or enhancements in certain international markets effectively, or at all.

Our operations involve the use of hazardous and toxic materials, and we must comply with environmental, health and safety laws and regulations, which can be expensive, and could have an adverse impact on our business.

Our operations use or generate small volumes of hazardous or toxic materials. We are therefore subject to a variety of federal, state and local regulations relating to the use, handling, storage, disposal and human exposure to hazardous and toxic materials. Liability under environmental laws can be joint and several and without regard to comparative fault, and environmental laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with violations, which could have an adverse impact on our business. Although we believe that our activities conform in all material respects with

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environmental, health and safety laws, there can be no assurance that violations of environmental, health and safety laws will not occur in the future as a result of human error, accident, equipment failure or other causes. The failure to comply with past, present or future laws could result in the imposition of fines, third-party property damage and personal injury claims, investigation and remediation costs, the suspension of production or a cessation of operations. We also expect that our operations will be affected by other new environmental and health and safety laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs, and may require us to change how we manufacture our products, which could have an adverse impact on our business.

Risks Relating to Capital Requirements and Finances

We may need substantial additional funding and may be unable to raise capital when needed, which could force us to delay or reduce our commercialization efforts or product development programs.

We believe that the net proceeds from our IPO, together with the net proceeds from our underwritten public offering of common stock in the first quarter of 2017, our existing cash and cash equivalents and anticipated revenue will be sufficient to meet our capital requirements and fund our operations for at least 24 months. However, we have based these estimates on assumptions that may prove to be incorrect, and we could spend our available financial resources much faster than we currently expect. Any future funding requirements will depend on many factors, including:

In March 2016, we filed, and the SEC declared effective, an unallocated, or “universal,” shelf registration statement on Form S-3 which permits us to offer and sell, from time to time, on a continuous or delayed basis in the future, up to $100 million of equity, debt or other types of securities described in the registration statement, or any combination of such securities, in one or more future public offerings, and permits certain selling stockholders to sell up to 3 million shares of our common stock from time to time in one or more offerings. We used this shelf registration statement to sell approximately 2.9 million shares of common stock in the first quarter of 2017 public offering, in addition to approximately 1.2 million shares of common stock sold by certain selling stockholders in the offering. If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Any future debt financing into which we enter may impose upon us covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third-parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us.

Furthermore, we cannot be certain that additional funding will be available on acceptable terms, if at all. If we do not have, or are not able to obtain, sufficient funds, we may have to delay development or commercialization of our products or license to third-parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. We also may have to reduce marketing, customer support or other resources devoted to our products or cease operations. Any of these factors could harm our operating results.

We have outstanding indebtedness under our credit facility which beginning in March 2017, we are required to make monthly one payment of principal and interest in the amount of $1.8 million and 21 equal month payment of principal and interest in the amount of $1.0 million each. If we do not pay off or refinance this debt, these payments may adversely affect our operating results

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and cash flows. In addition, the terms of our credit agreement may restrict our current and future operations, and could affect our ability to respond to changes in our business and to manage our operations.

We have a credit facility with Oxford Finance LLC. As of December 31, 2016, we had $20.0 million of debt outstanding and no unused credit under the credit facility. In February 2017, we entered into an amendment to our amended and restated loan and security agreement to allow principal payments due on February 1, 2017 and March 1, 2017 to be instead paid on March 15, 2017. Accordingly, on March 15, 2017, we will make one principal and interest payment of $1.8 million and beginning on April 1, 2017 make 21 equal monthly payment of principal and interest in the amount of approximately $1.0 million each. In addition to the principal and interest payments under the credit facility, we are required to pay a final payment fee of 7.15% on all amounts outstanding, which is being accrued over the credit facility term and will be due at the earlier of maturity or prepayment. If we repay the amounts borrowed under the credit facility prior to maturity, we will also be required to pay a prepayment fee equal to 0.75% with respect to the principal amount that is prepaid. We have agreed not to pledge or otherwise encumber our intellectual property assets, except for permitted liens, as such terms are defined in the credit facility and except as otherwise provided for in the credit facility. The credit facility contains no financial covenants, and we were in compliance with its affirmative and restrictive covenants as of December 31, 2016. If we do not pay off or refinance this debt, these payments may adversely affect our operating results and cash flows. In addition, the credit agreement contains events of default customary for transactions of this type, including non-payment, misrepresentation, breach of covenants, and bankruptcy. In the event we fail to satisfy our covenants, or otherwise go into default, Oxford Finance LLC, has a number of remedies, including sale of our assets and acceleration of all outstanding indebtedness, which would have a material adverse effect on our financial condition.

Our ability to use our net operating losses and research and development credit carryforwards to offset future taxable income may be subject to certain limitations.

In general, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change,” generally defined as a greater than 50% change by value in its equity ownership over a three-year period, is subject to limitations on its ability to utilize its pre-change net operating losses, or NOLs, and its research and development credit carryforwards to offset future taxable income. Our existing NOLs and research and development credit carryforwards may be subject to limitations arising from previous ownership changes, and if we undergo an ownership change, our ability to utilize NOLs and research and development credit carryforwards could be further limited by Sections 382 and 383 of the Code. Future changes in our stock ownership, some of which might be beyond our control, could result in an ownership change under Section 382 of the Code. For these reasons, in the event we experience a change of control, we may not be able to utilize a material portion of the NOLs and research and development credit carryforwards, even if we attain profitability.

Risks Relating to Intellectual Property Matters

Intellectual property rights may not provide adequate protection and third-parties from which we license intellectual property may not enforce their intellectual property rights, which may permit third-parties to compete against us more effectively.

Our success depends significantly on our ability to protect our proprietary rights to the technologies and inventions used in, or embodied by, our products. To protect our proprietary technology, we rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, as well as nondisclosure, confidentiality and other contractual restrictions in our consulting and employment agreements. These legal means afford only limited protection, however, and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Furthermore, while we have no reason to believe that any third parties hold rights of ownership to the intellectual property we regard as our own, we cannot assure shareholders that third parties of which we are unaware do not possess such rights, or that we will not be subject to, and forced to defend against, third-party claims of ownership to our intellectual property in the future. In either case, our ability to compete effectively could be harmed.

Patents

The process of applying for patent protection itself is time-consuming and expensive and we cannot assure you that all of our patent applications will issue as patents or that, if issued, they will issue in a form that will be advantageous to us. The rights granted to us under our patents, including prospective rights sought in our pending patent applications, may not be meaningful or provide us with any commercial advantage, and they could be opposed, contested, or circumvented by our competitors or declared invalid or unenforceable in judicial or administrative proceedings. We may not be able to file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. It is also possible that we will fail to identify patentable aspects of our research and development output before it is too late to obtain patent protection. We may not have the right to control the preparation, filing and prosecution of patent applications, or to maintain the rights to patents licensed by third-parties. For example, we do not control the prosecution of the patent applications licensed to us under the Acclarent License described above. Therefore, these patents and applications may not be prosecuted or enforced in a manner consistent with the best interests of our business. If such licensors fail to maintain such patents, or lose rights to those patents, the rights we have licensed may be

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reduced or eliminated. In addition, because the Acclarent License is non-exclusive, Acclarent could choose to also license the same intellectual property to other third-party competitors, which would also have a material adverse effect on our business.

We own numerous issued patents and pending patent applications relating to our technology and products. The rights granted to us under these patents, including prospective rights sought in our pending patent applications, could be opposed, contested or circumvented by our competitors or declared invalid or unenforceable in judicial or administrative proceedings. If any of our patents are challenged, invalidated or legally circumvented by third-parties, and if we do not own other enforceable patents protecting our products, competitors could market products and use processes that are substantially similar to, or superior to, ours, and our business will suffer. In addition, the patents we own may not be of sufficient scope or strength to provide us with any meaningful protection or commercial advantage, and competitors may be able to design around our patents or develop products that provide outcomes comparable to ours without infringing on our intellectual property rights.

Recent patent reform legislation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents. On September 16, 2011, the Leahy-Smith America Invents Act, or the Leahy-Smith Act, was signed into law. The Leahy-Smith Act includes a number of significant changes to U.S. patent law. These include provisions that affect the way patent applications are prosecuted, redefine prior art, may affect patent litigation, and switch the U.S. patent system from a “first-to-invent” system to a “first-to-file” system. Under a “first-to-file” system, assuming the other requirements for patentability are met, the first inventor to file a patent application generally will be entitled to the patent on an invention regardless of whether another inventor had made the invention earlier. The U.S. Patent and Trademark Office, or USPTO, recently developed new regulations and procedures to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first-to-file provisions, only became effective on March 16, 2013. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business. However, the Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business and financial condition. In addition, patent reform legislation may pass in the future that could lead to additional uncertainties and increased costs surrounding the prosecution, enforcement, and defense of our patents and applications. We may be subject to a third-party preissuance submission of prior art to the USPTO, or become involved in opposition, derivation, reexamination, inter partes review, post-grant review or other patent office proceedings or litigation, in the United States or elsewhere, challenging our patent rights or the patent rights of others. An adverse determination in any such submission, proceeding or litigation could reduce the scope of, or invalidate, our patent rights, allow third-parties to commercialize our technology or products and compete directly with us, without payment to us, or result in our inability to manufacture or commercialize products without infringing third-party patent rights.

Moreover, the USPTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. In addition, periodic maintenance fees on issued patents often must be paid to the USPTO and foreign patent agencies over the lifetime of the patent. While an unintentional lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. Non-compliance events that could result in abandonment or lapse of a patent or patent application include, but are not limited to, failure to respond to official actions within prescribed time limits, non-payment of fees and failure to properly legalize and submit formal documents. If we fail to maintain the patents and patent applications covering our products or procedures, we may not be able to stop a competitor from marketing products that are the same as or similar to our products, which would have a material adverse effect on our business.

Furthermore, we do not have patent rights in certain foreign countries in which a market may exist in the future, and the laws of many foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. Thus, we may not be able to stop a competitor from marketing and selling in foreign countries products that are the same as or similar to our products.

Trademarks

We rely on our trademarks as one means to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. Our trademark applications may not be approved, however. Third-parties may oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands. Our competitors may infringe our trademarks and we may not have adequate resources to enforce our trademarks.

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Trade Secrets and Know-How

We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors, former employees or current employees, despite the existence generally of confidentiality agreements and other contractual restrictions. Monitoring unauthorized uses and disclosures of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property will be effective.

Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. Competitors could purchase our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, willfully infringe our intellectual property rights, design around our protected technology or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected so as to protect our market against competitors’ products and methods, our competitive position could be adversely affected, as could our business.

We may in the future be a party to patent and other intellectual property litigation and administrative proceedings that could be costly and could interfere with our ability to successfully market our products.

The medical device industry has been characterized by frequent and extensive intellectual property litigation and is highly competitive. Our competitors or other patent holders may assert that our products and/or the methods employed in our products are covered by their patents. If our products or methods are found to infringe, we could be prevented from manufacturing or marketing our products. In the event that we become involved in such a dispute, we may incur significant costs and expenses and may need to devote resources to resolving any claims, which would reduce the cash we have available for operations and may be distracting to management. We do not know whether our competitors or potential competitors have applied for, will apply for, or will obtain patents that will prevent, limit or interfere with our ability to make, use, sell, import or export our products. Competing products may also be sold in other countries in which our patent coverage might not exist or be as strong. If we lose a foreign patent lawsuit, alleging our infringement of a competitor’s patents, we could be prevented from marketing our products in one or more foreign countries. We may also initiate litigation against third-parties to protect our own intellectual property. Our intellectual property has not been tested in litigation. If we initiate litigation to protect our rights, we run the risk of having our patents invalidated, which would undermine our competitive position.

Litigation related to infringement and other intellectual property claims, with or without merit, is unpredictable, can be expensive and time-consuming, and can divert management’s attention from our core business. If we lose this kind of litigation, a court could require us to pay substantial damages, treble damages and attorneys’ fees, and could prohibit us from using technologies essential to our products, any of which would have a material adverse effect on our business. If relevant patents are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our products unless we can obtain licenses to use technology or ideas covered by such patents. We do not know whether any necessary licenses would be available to us on satisfactory terms, if at all. If we cannot obtain these licenses, we could be forced to design around those patents at additional cost or abandon the product altogether. As a result, our ability to grow our business and compete in the market may be harmed.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of non-competition or non-solicitation agreements with our competitors.

We could in the future be subject to claims that we or our employees have inadvertently or otherwise used or disclosed alleged trade secrets or other proprietary information of former employers or competitors. In addition, we may in the future be subject to claims that we caused an employee to breach the terms of his or her non-competition or non-solicitation agreement. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and could be a distraction to management. If our defense to those claims fails, in addition to paying monetary damages, a court could prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies or features that are important or essential to our products could have an adverse impact on our business, and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. Any litigation or the threat thereof may adversely affect our ability to hire employees or contract with independent sales representatives. A loss of key personnel or their work product could hamper or prevent our ability to commercialize our products, which could have an adverse impact on our business.

Risks Related to Our Common Stock

The price of our common stock may be volatile and fluctuate substantially, which could result in substantial losses for our stockholders.

Our stock price has been, and is likely to continue to be, volatile. During 2016, the sale price of our common stock ranged from $13.72 to $22.63. Our daily trading volume ranged from 9,200 to 309,500 during 2016. In recent years, the stock markets generally have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating

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performance of those companies. Broad market and industry factors may significantly affect the market price of our common stock, regardless of our actual operating performance. The market price of our common stock may fluctuate substantially due to many factors, including, among others:

In addition, in the past, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Securities litigation brought against us following volatility in our stock price, regardless of the merit or ultimate results of such litigation, could result in substantial costs, which would hurt our financial condition and operating results and divert management’s attention and resources from our business.

Securities analysts may not publish favorable research or reports about our business or may publish no information at all, which could cause our stock price or trading volume to decline.

The trading market for our common stock may be influenced to some extent by the research and reports that industry or financial analysts publish about us and our business. We do not control these analysts. If any of the analysts who cover us provide inaccurate or unfavorable research or issue an adverse opinion regarding our stock price, our stock price could decline. If one or more of these analysts cease coverage of us or fail to publish reports covering us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline.

We are an “emerging growth company” and the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take, and intend to take, advantage of certain exemptions and relief from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” In particular, while we are an “emerging growth company” (1) we will not be required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, (2) we will be exempt from any rules that could be adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotations or a supplement to the auditor’s report on financial statements, (3) we will be subject to reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and (4) we will not be required to hold nonbinding advisory votes on executive compensation or stockholder approval of any golden parachute payments not previously approved.

In addition, while we are an “emerging growth company” we will not be required to comply with any new financial accounting standard until such standard is generally applicable to private companies. As a result, our consolidated financial statements may not be comparable to companies that are not “emerging growth companies” or elect not to avail themselves of this provision.

We may remain an “emerging growth company” until as late as December 31, 2020, the fiscal year-end following the fifth anniversary of the completion of our IPO, though we may cease to be an “emerging growth company” earlier under certain circumstances, including if (1) we have more than $1.0 billion in annual revenue in any fiscal year, (2) the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 or (3) we issue more than $1.0 billion of non-convertible debt over a three-year period.

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The exact implications of the JOBS Act are still subject to interpretations and guidance by the SEC and other regulatory agencies, and we cannot assure you that we will be able to take advantage of all of the benefits of the JOBS Act. In addition, investors may find our common stock less attractive to the extent we rely on the exemptions and relief granted by the JOBS Act. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may decline or become more volatile.

Our directors, officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.

As of February 15, 2017, our officers, directors and principal stockholders each holding more than 5% of our common stock, collectively control approximately 45% of our outstanding common stock. As a result, these stockholders, if they were to act together, would be able to control the management and affairs of our company and most matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change of control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of our other stockholders.

Future sales of shares could cause our stock price to decline.

Our stock price could decline as a result of sales of a large number of shares of our common stock or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. Persons who were our stockholders prior to our IPO continue to hold a substantial number of shares of our common stock, and sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares of common stock intend to sell shares, could reduce the market price of our common stock.

Moreover, certain holders of our common stock have rights to require us to register their shares under the Securities Act, and to participate in future registrations of securities by us, subject to certain conditions. In addition, shares of common stock that are either subject to outstanding options, issuable upon vesting of restricted stock units or reserved for future issuance under our stock incentive plans are eligible for sale in the public market to the extent permitted by the provisions of various vesting schedules and Rule 144 and Rule 701 under the Securities Act and, in any event, we have filed a registration statement permitting shares of common stock issuable under our stock incentive plans to be freely sold in the public market. If these additional shares of common stock are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

Certain of our employees, executive officers and directors have entered or may enter into Rule 10b5-1 plans providing for sales of shares of our common stock from time to time. Under a Rule 10b5-1 plan, a broker executes trades pursuant to parameters established by the employee, director or officer when entering into the plan, without further direction from the employee, officer or director. A Rule 10b5-1 plan may be amended or terminated in some circumstances. Our employees, executive officers and directors also may buy or sell additional shares outside of a Rule 10b5-1 plan when they are not in possession of material, nonpublic information. Shares of our common stock sold under these plans, or the perception that such shares may be sold in the public market, may adversely affect the trading price of our common stock. In addition, sales by our insiders under these plans may adversely affect investors’ views of the future value of our common stock.

In the event that our internal control over financial reporting is perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and the trading price of our common stock could decline.

We are subject to the periodic reporting requirements of the Exchange Act. As a result, our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. As a public company, we are required, under Section 404(a) of the Sarbanes-Oxley Act of 2002, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. We designed our disclosure controls and procedures to provide reasonable assurance that information we must disclose in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

We believe that any disclosure controls and procedures, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur in the future and not be detected.

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In addition, once we cease to be an “emerging growth company” under the federal securities laws, our auditors will be required to express an opinion on the effectiveness of our internal controls under Section 404(b) of the Sarbanes-Oxley Act. While we may remain an “emerging growth company” until as late as December 31, 2020, the fiscal year-end following the fifth anniversary of the completion of our IPO, we may cease to be an “emerging growth company” earlier under certain circumstances and that could accelerate our timeline for complying with Section 404(b).

If we are unable to confirm that our internal control over financial reporting is effective, or if our auditors, when required, are unable to express an opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, or be delayed in producing these financial reports, both of which could cause the price of our common stock to decline. We could also be subject to, among other things, regulatory or enforcement actions by the SEC and The Nasdaq Global Market and could be subject to securities litigation.

Provisions in our corporate charter documents and under Delaware law could make an acquisition of us more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our amended and restated certificate of incorporation and our amended and restated bylaws may discourage, delay or prevent a merger, acquisition or other change in control of us that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team. Among others, these provisions include that:

Moreover, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner. Furthermore, our amended and restated certificate of incorporation specifies that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for most legal actions involving actions brought against us by stockholders. We believe this provision benefits us by providing increased consistency in the application of Delaware law by chancellors particularly experienced in resolving corporate disputes, efficient administration of cases on a more expedited schedule relative to other forums

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and protection against the burdens of multi-forum litigation. However, the provision may have the effect of discouraging lawsuits against our directors and officers. The enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that, in connection with any applicable action brought against us, a court could find the choice of forum provisions contained in our amended and restated certificate of incorporation to be inapplicable or unenforceable in such action.

Because we do not anticipate paying any cash dividends on our capital stock in the foreseeable future, capital appreciation, if any, will be your sole source of gain.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business. In addition, our current credit facility precludes, and any future debt agreements may preclude, us from paying dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

None.

Our corporate headquarters and manufacturing facilities are located in Plymouth, Minnesota, where we occupy a total of approximately 52,000 square feet of leased office and warehouse space. The terms of our two leases both expire in June 2021. In connection with our XeroGel acquisition, we assumed a lease agreement for manufacturing facility space in Hayward, California through August 2017. We believe that our facilities are sufficient to meet our current needs and that suitable additional space will be available as and when needed on acceptable terms.

We are not currently a party to any material legal proceedings. We may at times be involved in litigation and other legal claims in the ordinary course of business. When appropriate in our estimation, we may record reserves in our consolidated financial statements for pending litigation and other claims.

Not applicable.

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PART II

Market Information

Our common stock has been listed on the NASDAQ Global Market under the symbol “ENTL” since January 29, 2015. The following table sets forth, for the fiscal quarters indicated, the high and low intra-day sales prices per share for our common stock as reported by the NASDAQ Global Market.

 

 

 

Holders

As of the close of business on February 15, 2017, there were 104 holders of record of our common stock. Since many of the shares of common stock are registered in “nominee” or “street” names, we believe that the total number of beneficial owners is considerably higher.

Dividend Policy

We have never declared or paid any cash dividends on our capital stock, and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. We currently intend to retain all available funds and any future earnings to support operations and to finance the growth and development of our business. In addition, our existing credit facility restricts our ability to pay dividends on our capital stock. Any future determination to pay dividends will be made at the discretion of our board of directors, subject to applicable laws and the restrictions set forth in our credit facility, and will depend upon, among other factors, our results of operations, financial condition, contractual restrictions and capital requirements. Our future ability to pay cash dividends on our capital stock may also be limited by the terms of any future debt or preferred securities or future credit facility.

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Performance Graph

The following graph compares the cumulative total stockholder return on our common stock with the cumulative total return of the NASDAQ Composite Index and the NASDAQ Medical Equipment Index for the period beginning on January 29, 2015, the first day our common stock was traded on The NASDAQ Global Market, and ending on December 31, 2016.

 

The above graph is based upon common stock and index prices calculated as of the end of each period. The closing price of our common stock on December 30, 2016, the last trading day of 2016, was $18.97 per share. The stock price performance of our common stock depicted in the graph above represents past performance only and is not necessarily indicative of future performance.

Recent Sales of Unregistered Securities

During the fourth quarter ended December 31, 2016, we did not sell any of our equity securities that were not registered under the Securities Act of 1933, as amended.

Repurchases of Equity Securities by the Issuer

We did not purchase any shares of our common stock or other equity securities of our company during the fourth quarter ended December 31, 2016.

Use of Proceeds

On January 28, 2015, the SEC declared effective our Registration Statement on Form S-1 (File No. 333-201237), as amended, filed in connection with our initial public offering. Pursuant to the Registration Statement, as well as the Registration Statement on Form S-1 (File No. 333-201741) filed on January 28, 2015 to register additional securities, we issued and sold an aggregate of approximately 5.3 million shares of our common stock at a price to the public of $17.00 per share (including approximately 0.7 million shares sold pursuant to an option granted to the underwriters). The offering commenced as of January 28, 2015 and did not terminate before all of the securities registered in the Registration Statements were sold on February 3, 2015. The syndicate of underwriters was led by Merrill Lynch, Pierce, Fenner & Smith Incorporated and Piper Jaffray & Co., as joint book-running managers, and William Blair and Canaccord Genuity acted as co-managers. We raised approximately $81.0 million in net proceeds after deducting $6.3 million in underwriting discounts and commissions and $2.7 million in other offering expenses. As of December 31, 2016, we have used approximately $38.0 million of the proceeds from our IPO to fund product development and clinical research expenses, sales, marketing, working capital and general corporate purposes and $11.0 million of such proceeds to pay the XeroGel acquisition purchase price. No payments were made by us to directors, officers or persons owning ten percent or more of our common stock or to their associates, or to our affiliates, other than payments in the ordinary course of business to officers for salaries and bonuses and to non-employee directors as compensation for board committee service. There has been no material change in the expected use of the net proceeds from our IPO as described in our final prospectus, dated January 28, 2015, filed with the SEC pursuant to Rule 424(b).

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The following tables set forth, for the periods and as of the dates indicated, our selected financial data. The consolidated statements of operations data for the years ended December 31, 2016, 2015 and 2014 and the consolidated balance sheet data as of December 31, 2016 and 2015 are derived from our audited consolidated financial statements included in this Annual Report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2013 and 2012 and consolidated balance sheet data as of December 31, 2014, 2013 and 2012 are derived from our audited financial statements that are not included in this Annual Report on Form 10-K. You should read the following information together with the more detailed information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Our historical results are not indicative of the results to be expected in the future.

 

 

 

 

 

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to those statements included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Some of the numbers included herein have been rounded for the convenience of presentation. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Business Overview

We are a medical technology company focused on delivering superior patient and physician experiences through products designed for the minimally invasive treatment of chronic and recurrent sinusitis in both adult and pediatric patients. Our platform of products provides effective and easy-to-use solutions designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. Our three core product lines, XprESS™ Multi-Sinus Dilation Systems, MiniFESS™ Surgical Instruments, and FocESS™ Imaging & Navigation, are designed to enable ear, nose and throat, or ENT, physicians to conveniently and comfortably perform a broad range of procedures in the ENT physician office and simplify operating room based treatment. When used as a stand-alone therapy in the physician’s office, our balloon sinus dilation products are the only devices proven in a sufficiently powered prospective, multicenter, randomized, controlled trial to be as effective as functional endoscopic sinus surgery, or FESS, the primary surgical treatment for chronic and recurrent sinusitis. Patients treated with our products in this trial in the ENT physician office also experienced faster recovery, less bleeding at discharge, less use of prescription pain medication and fewer post-procedure debridements than patients receiving FESS.

We believe our minimally invasive balloon sinus dilation devices, along with the additional sinus surgery products we have sold, have facilitated a shift towards office-based treatment of chronic and recurrent sinusitis patients who are candidates for sinus surgery in the operating room. We believe this shift has been facilitated by our technology and clinical data, as well as procedure economics that are favorable to the healthcare system, patient and provider. Our XprESS family of products is used to treat patients with inflammation of the frontal, ethmoid, sphenoid and maxillary sinuses and is specifically designed for ease-of-use in the ENT physician office setting. Our XprESS family of products includes our XprESS Pro device, our XprESS LoProfile device and our XprESS Ultra device. We derive a significant portion of our revenue from our XprESS family of products. Our research and development efforts are focused primarily on enhancing our XprESS family of products and broadening their indications for use, as well as developing new related products.

We consider new products to be any non-balloon products released within the last 24 months. As of December 31, 2016, new products included our Fiagon Image Guidance Systems and accessories, MiniFESS Tools, FocESS Scopes and accessories, Cyclone Sinonasal Suction and Irrigation System, Entellus Medical Shaver System and FocESS HD Wireless Camera System.

In June 2016, we entered into an amended and restated agreement with Fiagon NA Corporation that, subject to certain limited exceptions for third parties that were then distributing Fiagon products, grants us exclusive distribution rights for Fiagon Image Guidance Systems, or Fiagon IGS, and certain components, parts and related ancillary products to ENT physicians in hospitals, physician offices and ambulatory surgery centers, or ASCs, in the United States, certain U.S. territories and Canada.

In June 2016, we acquired and entered into an exclusive license for the XeroGel™ assets with CogENT Therapeutics, LLC for $11.0 million in cash. We refer to this transaction as the XeroGel acquisition. Under the terms of the agreements, we became the manufacturer and continue to sell XeroGel nasal packing material to hospitals, offices and ASCs. Prior to the transaction, we were the exclusive distributor of XeroGel in the United States. The distribution agreement between the two parties was terminated in connection with the transaction. As a result of the XeroGel nasal packing material acquisition, we began recognizing all XeroGel revenue on a gross basis effective June 29, 2016, the date of the acquisition.

Our direct U.S. sales force engages in sales and promotional activities focused on ENT physicians. As of December 31, 2016, we have expanded our sales force to include 90 full quota-carrying representatives, an increase of 5% from our 86 full quota-carrying representatives as of December 31, 2015. We expect to continue to expand our full-quota carrying representatives to approximately 100 to 110 by the end of 2017, after which we anticipate driving efficiencies through a stabilized sales force.

In the second quarter of 2015, we established a subsidiary in the United Kingdom and started the process of selling our products in certain European countries using a combination of direct sales representatives and a network of independent distributors with experience in selling products into ENT markets in those regions. We intend to continue to increase our presence outside the United States through expansion of our U.K. sales force and as well as the addition of distributors.

In December 2016, the National Institute for Health and Care Excellence, or NICE, provided positive guidance for use of our XprESS Multi-Sinus Dilation System, recommending it for use in patients with uncomplicated chronic sinusitis who do not have severe nasal polyposis. In these patients, NICE has asserted that, in comparison with FESS, our XprESS Multi-Sinus Dilation System works as well, is associated with faster recovery times and can more often be performed under local anesthesia. The NICE guidance

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indicates that our XprESS Multi-Sinus Dilation System is cost saving compared to FESS based on device cost, length of FESS procedure and assuming the treatments are performed under local anesthetic, in an outpatient setting. NICE estimates that, by adopting our technology, the National Health Service in England may save up to £7.4 million per year by 2020. The NICE guidance is specific to the XprESS Multi-Sinus Dilation System and does not extend to any other balloon sinus dilation technology.

We invest substantial resources to educate ENT physicians and patients on the proven clinical advantages of stand-alone balloon sinus dilation. We have a diverse customer base of ENT physicians, hospitals and ASCs, with no single customer accounting for more than 5% of our revenue during the year ended December 31, 2016. Our customers are reimbursed by governmental and private health insurers for procedures using our products pursuant to reimbursement codes specific to the setting of the procedure. Our revenues are dependent upon the future market acceptance and adoption of our existing and new products, appropriate pricing and adequate level of coverage or reimbursement for procedures using such products.

When used as a stand-alone balloon sinus dilation procedure in the physician office setting, the practice expense component of the physician’s fee is intended to cover all or a portion of the cost of our products. When used in an operating room in an ASC or hospital, our products are typically utilized as tools used during FESS and are not separately reimbursed by third-party payors. Medicare issued a final rule on the Hospital Outpatient Prospective Payment System, or OPPS, for 2017 which includes a reduction of payments for certain outpatient procedures performed in the hospital when FESS is performed on more than two sinuses. The result is to bundle payments for multi-sinus surgery regardless of the number of sinuses being treated. On average we expect most hospitals will experience a reduction in Centers for Medicare and Medicaid Services, or CMS, reimbursement depending on the number of sinuses being treated.

We manufacture and assemble all of our proprietary products at our facility in Plymouth, Minnesota with components supplied by external suppliers. XeroGel nasal packing material continues to be manufactured in Hayward, California but we anticipate transitioning this to our Plymouth facility by the end of 2017. We increased the size of our Plymouth facility in February 2016 by approximately 19,700 square feet to a total of approximately 52,000 square feet. As of December 31, 2016, our manufacturing organization included 37 people. We expect the capacity of our current facility to be able to meet expected demand through at least the end of 2020.

Financial Overview

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Components of Our Results of Operations

Revenue

We derive a significant portion of our revenue from the sale of our XprESS family of products to ENT physicians, hospitals and ASCs. We also derive revenue from the sale of Fiagon IGS products for which we are the exclusive distributor in the United States and Canada, additional sinus diagnostic and surgery products, including our MiniFESS and FocESS product lines and our XeroGel product. Our revenue growth has been driven by, and we expect our revenue to continue to increase in the future as a result of, the introduction of new products, continued international expansion, increased physician awareness of our products, the clinical efficacy of stand-alone balloon sinus dilation and increased insurance coverage for balloon sinus dilation procedures. Any reversal in these trends could have a negative impact on our future revenue. In addition, we have expanded our sales and marketing infrastructure to help us drive and support revenue growth and we intend to continue this expansion. Our revenue has fluctuated, and we expect our revenue to continue to fluctuate, from quarter to quarter, as well as within each quarter, due to a variety of factors, including seasonality, timing of new product introductions, competitor product introductions, associated physician evaluations and competitor pricing changes.

Seasonality

Our business is typically affected by seasonality. In the first quarter, our results can be impacted by adverse weather and by the resetting of annual patient healthcare insurance plan deductibles, both of which may cause patients to delay elective procedures in which our products are used. In the second quarter, demand may be increased by the seasonal nature of allergies and the resultant onset of sinus-related symptoms. In the third quarter, the number of balloon sinus dilation and FESS procedures nationwide is historically lower than other quarters throughout the year, which we believe is attributable to the summer vacations of ENT physicians and their patients. In the fourth quarter, demand may be increased by the onset of the cold and flu season and related symptoms, as well as the desire of patients to spend the remaining balances in their flexible-spending accounts or because of lower out-of-pocket costs to patients who have met their annual deductibles under their health insurance plans.

Cost of Goods Sold and Gross Margin

Cost of goods sold for products we manufacture and assemble consists primarily of material costs, manufacturing overhead costs and direct labor. A significant portion of our cost of goods sold consists of manufacturing overhead costs. These overhead costs include the cost of quality assurance, material procurement, inventory control, facilities, equipment and operations supervision and management. Cost of goods sold for products we manufacture and assemble also includes depreciation expense for production equipment, shipping costs and royalty expense related to our licensing agreement with Acclarent, Inc. that is payable in connection with sales of certain of our manufactured products. For those products we sell as a distributor, our cost of goods sold consists primarily of transfer price. We expect cost of goods sold to increase in absolute dollars primarily as, and to the extent, our revenue grows.

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We calculate gross margin as gross profit divided by revenue. Our gross margin has been and we expect will continue to be affected by a variety of factors, including product sales mix, geographic mix and prices, launch of new products, the impact of distributor relationships, which generally result in lower gross margins, production volumes, manufacturing costs and product yields, and to a lesser extent, the implementation of cost-reduction strategies. We believe our gross margins are likely to be moderately lower in future periods compared to prior year periods.

Selling and Marketing Expenses

Selling and marketing expenses consist primarily of compensation for personnel, including base salaries and variable compensation associated with sales results, spending related to marketing, reimbursement and customer service functions, and stock-based compensation. Other selling and marketing expenses include training, travel expenses, promotional activities, conferences, trade shows and consulting services. If our revenue from sales of new or existing products increases, we expect our selling and marketing expenses to increase primarily as a result of increased compensation expenses for existing and new sales personnel, including stock-based compensation.

Research and Development Expenses

Research and development, or R&D, expenses consist primarily of engineering, product development, clinical studies to develop and support our products, regulatory expenses, consulting services, materials, depreciation, and other costs associated with products and technologies in development and next generation versions of current devices. These expenses include employee and non-employee compensation, including base salaries and bonus compensation, stock-based compensation, supplies, materials, quality assurance expenses allocated to R&D programs, consulting expenses, related travel expenses and facilities expenses, in each case related to R&D programs. Clinical expenses include clinical trial management and monitoring, payments to clinical investigators, data management and travel expenses and the cost of manufacturing products for clinical trials. We expect R&D expenses to increase modestly, as increases in expenses related to developing, enhancing and commercializing new products and technologies will be only partially offset by the timing and extent of expenses relating to clinical studies. We expect R&D expenses as a percentage of revenue to vary over time depending on the level and timing of initiating new product development efforts as well as our clinical development activities.

General and Administrative Expenses

General and administrative expenses consist primarily of compensation for personnel, including base salaries and bonus compensation, spending related to finance, information technology, human resource functions and stock-based compensation. Other general and administrative expenses include consulting expenses, travel expenses, credit card processing fees, professional services fees, audit fees, insurance costs and general corporate expenses, including allocated facilities-related expenses. As we expand our commercial infrastructure to both drive and support our planned growth in revenue, we expect our general and administrative expenses will continue to increase. We also expect to continue to incur legal, accounting, insurance and other professional service fees associated with being a public company, which may increase further when we are no longer able to rely on the “emerging growth company” exemption we are afforded under the Jumpstart Our Business Startups Act of 2012, or JOBS Act.

Other Expense, Net

Other expense, net primarily consists of interest expense payable under our credit facility, interest income and realized foreign currency gains and losses. Prior to our IPO, other expense, net also consisted of fair value adjustment related to our former convertible preferred stock warrants, which were accounted for as a liability and marked-to-market at each reporting period. In connection with the IPO, the warrants converted to warrants to purchase shares of our common stock and were no longer treated as a liability. We performed the final revaluation of the preferred stock warrant liability in January 2015 in connection with the completion of the IPO.

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Results of Operations

Comparison of Years Ended December 31, 2016 and 2015

 

Revenue

Revenue increased $13.6 million, or 22%, to $75.2 million during the year ended December 31, 2016, compared to $61.6 million during the year ended December 31, 2015. The growth in revenue was primarily attributable to new product introductions and an increase in sales of our XprESS family of products, through broader account penetration, both in the office and operating room partially offset by lower balloon prices.

Cost of Goods Sold and Gross Margin

Cost of goods sold increased $4.7 million, or 33%, to $18.7 million during the year ended December 31, 2016, compared to $14.1 million during the year ended December 31, 2015. The increase in cost of goods sold was primarily attributable to increased sales of new products and our XprESS family of products.

Gross margin for the year ended December 31, 2016 decreased to 75%, compared to 77% for the year ended December 31, 2015. Although unit sales increased, the gross margin decreased due to product and geographic mix of revenue and costs associated with expanded capacity for anticipated future growth.

Selling and Marketing Expenses

Selling and marketing expenses increased $11.9 million, or 26%, to $56.8 million during the year ended December 31, 2016, compared to $44.9 million during the year ended December 31, 2015. This increase was primarily attributable to a $10.4 million increase in salaries, benefits, stock-based compensation, travel expenses and other employee-related expenses as a result of increased headcount in our sales and marketing organization. In addition, other selling and marketing expenses increased $1.5 million primarily due to training and education activities.

Research and Development Expenses

R&D expenses increased $2.4 million, or 45%, to $7.8 million during the year ended December 31, 2016, compared to $5.4 million during the year ended December 31, 2015. This increase in R&D expenses was primarily due to an increase of $1.6 million in salaries, benefits and stock-based compensation. In addition, other research and development expenses increased $0.8 million.

General and Administrative Expense

General and administrative expenses increased $5.5 million, or 42%, to $18.5 million during the year ended December 31, 2016, compared to $13.0 million during the year ended December 31, 2015. This increase was primarily due to an increase of $2.7 million in salaries, benefits and stock-based compensation. In addition, business development, insurance, software and legal fees increased $2.0 million. Credit card processing fees, facility expenses and other general and administrative expenses accounted for the remaining increase.

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Other Expense, Net

Other expense, net, reflected an expense of $2.0 million during the year ended December 31, 2016 compared to an expense of $2.4 million during the year ended December 31, 2015. This decrease in expense was primarily attributable to the $0.3 million associated with the revaluation of our then-outstanding convertible preferred stock warrants in 2015.

We performed the final revaluation of the preferred stock warrant liability in January 2015 in connection with the completion of the IPO.

Income Tax Expense

Income tax expense reflected an expense of less than $0.1 million during the year ended December 31, 2016 attributable to the goodwill acquired in the XeroGel acquisition. We recognized no income tax expense during the year ended December 31, 2015.

Comparison of Years Ended December 31, 2015 and 2014

Revenue

Revenue increased $12.8 million, or 26%, to $61.6 million during the year ended December 31, 2015, compared to $48.8 million during the year ended December 31, 2014. The growth in revenue was primarily attributable to an increase in sales of our XprESS family of products through broader account penetration and increased sales of new products.

Cost of Goods Sold and Gross Margin

Cost of goods sold increased $3.3 million, or 31%, to $14.1 million during the year ended December 31, 2015, compared to $10.7 million during the year ended December 31, 2014. The increase in cost of goods sold was primarily attributable to the growth in sales of our XprESS family of products and to a lesser extent, increased sales of new products.

Gross margin for the year ended December 31, 2015 decreased to 77%, compared to 78% for the year ended December 31, 2014. Although unit sales increased, the gross margin decreased due to product and geographic mix, as well as increased overhead costs.

Selling and Marketing Expenses

Selling and marketing expenses increased $12.2 million, or 37%, to $44.9 million during the year ended December 31, 2015, compared to $32.8 million during the year ended December 31, 2014. This increase was primarily attributable to an $8.0 million increase in salaries, benefits, stock-based compensation, travel expenses and other employee-related expenses as a result of increased headcount in our sales and marketing organization. In addition, other selling and marketing expenses increased $4.2 million.

Research and Development Expenses

R&D expenses increased $1.1 million, or 25%, to $5.4 million during the year ended December 31, 2015, compared to $4.3 million during the year ended December 31, 2014. This increase in R&D expenses was primarily due to an increase of $0.8 million in salaries, benefits, stock-based compensation, travel expenses and other employee-related expenses. In addition, other research and development expenses increased $0.3 million.

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General and Administrative Expenses

General and administrative expenses increased $6.9 million, or 114%, to $13.0 million during the year ended December 31, 2015, compared to $6.1 million during the year ended December 31, 2014. This increase was primarily due to an increase of $3.0 million in salaries, stock-based compensation, benefits and other employee-related expenses. In addition, external consultant, contract and other outside services fees increased $1.9 million and insurance, software and legal fees increased $1.2 million. Credit card processing fees, facility expenses and other general and administrative expenses accounted for the remaining increase.

Other Expense, Net

Other expense, net, reflected an expense of $2.4 million during the year ended December 31, 2015, compared to an expense of $1.8 million during the year ended December 31, 2014. This increase was primarily attributable to a $0.4 million increase in interest expense related to our credit facility and a $0.3 million increase associated with the revaluation of our then-outstanding convertible preferred stock warrants, partially offset by a $0.1 million increase in interest income related to our available for sale securities.

We performed the final revaluation of the preferred stock warrant liability in January 2015 in connection with the completion of the IPO.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and assumptions for the reported amounts of assets, liabilities, revenue, expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material.

While our significant accounting policies are more fully described in Note B to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective and complex judgments.

Revenue Recognition

We recognize revenue when persuasive evidence of a sales arrangement exists, delivery of goods has occurred through the transfer of title and risks and rewards of ownership, the selling price is fixed or determinable and collectability is reasonably assured. Revenue is reported net of the allowance for sales returns. Taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between a seller and a customer are not recorded as revenue.

We entered into a distribution agreement with CogENT Therapeutics, LLC, or CogENT, in September 2013 and exclusively distributed XeroGel nasal packing material in the United States from October 2013 to June 2016. For products shipped from the CogENT warehouse to customers, CogENT was responsible for all manufacturing, order fulfillment, quality and regulatory requirements of the product. For these direct shipment orders, we did not take title to CogENT products prior to products being ordered by customers or in the event CogENT products are returned by customers. We recorded transactions under this arrangement on a net basis based on the difference between the amounts billed to customers less the amounts paid to CogENT for the XeroGel product. In June 2016, we acquired and entered into an exclusive license for the XeroGel assets with CogENT for $11.0 million in cash. Under the terms of the agreements, we now manufacture and sell XeroGel nasal packing material to hospitals, offices and ASCs. The distribution agreement between the two parties was terminated in connection with the XeroGel acquisition, and we began recognizing all XeroGel revenue on a gross basis effective June 29, 2016.

Our net revenue from XeroGel sales for the period January 1, 2016 through June 28, 2016 and the years ended December 31, 2015 and 2014 was approximately $0.7 million, $1.2 million and $0.8 million, respectively. We record transactions for XeroGel sales for which we take title, ship the product and handle returns on a gross basis. The amounts of revenue recorded on a gross basis from XeroGel sales for the period from January 1, 2016 through June 28, 2016 and the years ended December 31, 2015 and 2014 was approximately $0.1 million, $0.2 million and $0.1 million, respectively.                              

Stock-Based Compensation

We account for all stock-based compensation awards using a fair value method. We record stock options at their estimated grant date fair value using the Black-Scholes option pricing model. We recognize the fair value of each award as an expense on a straight-line basis over the requisite service period, generally the vesting period of the equity grant.

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The valuation model for stock compensation expense requires us to make assumptions and judgments about the variables used in the calculation including the expected life (weighted-average period of time that the options granted are expected to be outstanding), the expected volatility of our common stock, an assumed risk-free interest rate, the dividend yield and the estimated forfeitures of unvested stock options. We have opted to use the “simplified method” for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option. Due to our limited operating history and company-specific historical and implied volatility data, we have based our estimate of expected volatility on the blended historical volatility of a group of similar companies that are publicly traded and our historical volatility. The historical volatility data was computed using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based payments. We will continue to analyze the historical stock price volatility and expected term assumptions as more historical data for our common stock becomes available. The risk-free rate assumption is based on the U.S. Treasury instruments with maturities similar to the expected term of our stock options. The expected dividend assumption is based on our history of not paying dividends and our expectation that we will not declare dividends for the foreseeable future.

The assumptions used in the Black-Scholes option pricing model for the periods specified below are as follows:

 

 

Prior to our IPO, our board of directors, with the assistance of management determined the fair value of our common stock on the date of grant based on several factors, including:

For stock options granted subsequent to our IPO, the exercise price is equal to the closing sale price of our common stock on the grant date, as reported on the NASDAQ Global Market.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Intangible assets are recorded at their estimated fair value at the date of acquisition. In the year following the period in which identified intangible assets become fully amortized, the fully amortized balances are removed from the gross asset and accumulated amortization amounts. Goodwill is not amortized, but is instead subject to impairment testing. Intangible assets with finite lives are amortized using a straight-line method over their respective useful lives.

Goodwill Impairment

We chose November 1 to assess our annual goodwill for any impairment in order to closely align with the timing of our annual planning process. On an annual basis, or more frequently upon the occurrence of certain events, we test for goodwill impairment using a three-step process. The first step of the goodwill impairment test is to perform a qualitative assessment before calculating the fair value of the reporting unit. If based on the qualitative factors, it is more likely than not that the fair value of the reporting unit is less than the carrying amount of the reporting unit, we are then required to perform the next step of the goodwill impairment test. The second step is to identify a potential impairment by comparing the calculated fair value of a reporting unit with its carrying amount. The fair value of a reporting unit is determined based on a discounted cash flow analysis and further analyzed using other methods of valuation. A discounted cash flow analysis requires us to make various assumptions, including assumptions about future cash flows,

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growth rates and discount rates. The assumptions about future cash flows and growth rates are based on our long-term projections. In addition, an assumed terminal value is used to project future cash flows beyond base years. Assumptions used in our impairment testing are consistent with our internal forecasts and operating plans. Our discount rate was based on our debt and equity balances, adjusted for current market conditions and investor expectations of return on its equity. If the fair value of a reporting unit exceeds our carrying amount, there is no impairment. If the calculated fair value is less than the carrying value, the third step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with its carrying amount. To the extent the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, a write-down of the reporting unit’s goodwill would be necessary.

We performed a qualitative assessment of the reporting unit and determined that it was not more likely than not that the fair value of the reporting unit was less than the carrying amount of the reporting unit; therefore, we were not required to perform the next step of the goodwill impairment test. For the year ended December 31, 2016, no goodwill impairment was identified. We did not have any goodwill on our consolidated balance sheet prior to the XeroGel acquisition.

Recent Accounting Pronouncements

In May 2014, Financial and Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09, Revenue from Contracts with Customers. This standard will eliminate the transaction and industry specific revenue recognition guidance under current U.S. GAAP and replace it with a principles based approach for determining revenue recognition. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606 – Revenue from Contracts with Customers, to clarify the Codification or to correct unintended application of guidance. The new guidance is effective for private companies and emerging growth companies annual and interim periods beginning after December 15, 2018. ASU 2014-09 allows for full retrospective adoption applied to all periods presented or modified retrospective adoption with the cumulative effect of initially applying the standard recognized at the date of initial application. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations – Reporting Revenue Gross versus Net. This ASU clarifies the revenue recognition implementation guidance for preparers on certain aspects of principal versus agent consideration. The amendments in this ASU are effective private companies and emerging growth companies beginning after December 15, 2018. The adoption of ASU 2016-08 will be concurrently adopted with the adoption of ASU 2014-09. We plan to adopt the new guidance beginning January 1, 2019.

We have performed a review of the requirements of the new guidance and have identified which of our revenue streams will be within the scope of ASU 2014-09.  We are working through an adoption plan which includes a review of customer contracts, applying the five-step model of the new standard, to each revenue stream and comparing the results to our current accounting; an evaluation of the method of adoption; and assessing changes that might be necessary to information technology systems, processes, and internal controls to capture new data and address changes in financial reporting. Because of the nature of the work that remains, at this time we are unable to reasonably estimate the impact of adoption on our consolidated financial statements. 

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance, which changes the presentation of debt issuance costs in financial statements. Under ASU 2015-03, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. ASU 2015-03 is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. A company should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, a company is required to comply with the applicable disclosures for a change in an accounting principle. The guidance only affects the presentation of debt issuance costs in the balance sheet and has no impact on results of operations. We applied ASU 2015-03 on January 1, 2016 and reclassified debt issuance costs from long-term assets to long-term debt. Debt issuance costs included in long-term debt in the accompanying consolidated financial statements were $0.1 million and $0.2 million at December 31, 2016 and December 31, 2015, respectively.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. We do not expect that adoption of ASU 2016-01 will have a significant impact on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases, which requires that lease arrangements longer than twelve months result in an entity recognizing an asset and liability. The updated guidance in this ASU are for private companies and emerging growth companies beginning after December 15, 2019. We are currently evaluating the impact of the updated guidance on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation, which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, the estimation of forfeitures, shares withheld for taxes and classification of shares withheld for taxes on the statement

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of cash flows. As part of the adoption of this guidance we have elected to account for forfeitures of share-based awards as they occur.  We adopted ASU 2016-09 on January 1, 2017 and there was not a material impact on the consolidated financial statements.  

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses, to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2020; the ASU allows for early adoption as of the beginning of an interim or annual reporting period beginning after December 15, 2018. We are currently assessing the impact that this standard will have on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statements of Cash Flows – Classifications of Certain Cash Receipts and Cash Payments, to clarify how companies present and classify certain cash receipts and cash payments in the statement of cash flows. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018; the ASU allows for early adoption. We do not believe that adoption of ASU 2016-15 will have a significant impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations – Clarifying the Definition of a Business, to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or dispositions) of assets or businesses. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018. The ASU allows for early adoption. We do not believe that adoption of ASU 2017-01 will have a significant impact on our consolidated financial statements.

Jumpstart Our Business Startups Act of 2012 (JOBS Act)

Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We intend to take advantage of such extended transition period. Section 107 of the JOBS Act provides that we can elect to opt out of the extended transition period at any time, which election is irrevocable.

We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements under the JOBS Act. Subject to certain conditions, as an emerging growth company, we may rely on certain of these exemptions, including without limitation, (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (ii) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earlier of (a) the last day of the fiscal year in which we have total annual gross revenues of $1.0 billion or more; (b) the date on which we have issued more than $1.0 billion in nonconvertible debt during the previous six years; or (c) the date on which we are deemed to be a large accelerated filer (with at least $700 million in public float) under the rules of the SEC; or (d) December 31, 2020, the last day of the fiscal year following the fifth anniversary of our IPO.

Liquidity and Capital Resources

Overview

As of December 31, 2016, we had cash and cash equivalents of $21.4 million, short-term investments of $10.8 million and an accumulated deficit of $150.8 million, compared to cash and cash equivalents of $28.5 million, short-term investments of $38.2 million and an accumulated deficit of $122.1 million as of December 31, 2015. Our primary sources of capital have been from product sales, net proceeds from our IPO, net proceeds from our recent first quarter 2017 public offering, private placements of our convertible preferred securities before our IPO, and amounts borrowed under our credit facility. As of December 31, 2016, we had $20.0 million of borrowings and no unused credit under our credit facility.

In March 2016, we filed, and the SEC declared effective, an unallocated, or “universal,” shelf registration statement on Form S-3 which permits us to offer and sell, from time to time, on a continuous or delayed basis in the future, up to $100 million of equity, debt or other types of securities described in the registration statement, or any combination of such securities, in one or more future public offerings, and permits certain selling stockholders to sell up to 3 million shares of our common stock from time to time in one or more offerings.

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In the first quarter of 2017, we completed a public offering of shares of our common stock under the shelf registration statement, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain of our existing stockholders also sold approximately 1.2 million shares of common stock in the offering. We received estimated net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us. We did not receive any proceeds from the sale of shares by the existing selling stockholders.

We believe that our existing cash and cash equivalents, short-term investments and anticipated revenue will be sufficient to meet our anticipated capital requirements and fund our operations beyond 2018. However, we have based these estimates on assumptions that may prove to be incorrect, and we could spend our available financial resources faster than we anticipated. If our current capital sources are insufficient to satisfy our liquidity requirements, or if we choose to take advantage of new product and market opportunities to expand our business and increase our revenues, we may sell additional equity or debt securities, or refinance, restructure, or enter into a new credit facility. If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Additional financing may not be available at all, or in amounts or on terms acceptable to us. If we are unable to obtain additional financing, we may be required to delay the development, commercialization and marketing of our products.

As of December 31, 2016, cash held by our foreign subsidiary that was not available to fund domestic operations unless repatriated was $0.9 million. We do not intend to repatriate this cash; however, if circumstances changed and these funds were needed for our U.S. operations, we would be required to accrue and pay U.S. taxes to repatriate these funds.  

Cash Flows

 

Net Cash Used in Operating Activities

Net cash used in operating activities for 2016 was $20.1 million, consisting primarily of a net loss of $28.7 million, partially offset by non-cash charges of $8.6 million. Non-cash charges consisted primarily of stock-based compensation, depreciation and amortization, the accretion of the final payment fee on our credit facility and the amortization of premium on investments.

Net cash used in operating activities for 2015 was $14.2 million, consisting primarily of a net loss of $18.3 million and an increase in net operating assets of $0.9 million, partially offset by non-cash charges of $5.0 million. The increase in net operating assets was primarily due to increases in accounts receivable and inventory and a decrease in accounts payable, partially offset by an increase in accrued expenses and a decrease in other non-current assets. Non-cash charges consisted primarily of stock-based compensation, depreciation, the amortization of premium on investments, the accretion of the final payment fee on our credit facility and the change in the fair value of convertible preferred stock warrants.

Net cash used in operating activities for 2014 was $8.8 million, consisting primarily of a net loss of $6.9 million and an increase in net operating assets of $3.3 million, partially offset by non-cash charges of $1.4 million. The increase in net operating assets was primarily due to increases in accounts receivable and inventory and a decrease in accounts payable, partially offset by an increase in accrued expenses and a decrease in other non-current assets. Non-cash charges consisted primarily of stock-based compensation, depreciation, the amortization of premium on investments, the change in the fair value of convertible preferred stock warrants and the accretion of the final payment fee on our credit facility.

Net Cash Provided by (Used in) Investing Activities

Net cash provided by investing activities in 2016 was $12.3 million, consisting primarily of net proceeds of maturities of short-term investments of $59.4 million, partially offset by $32.2 million in purchases of short-term investments, $11.0 million to pay the XeroGel acquisition purchase price and $4.0 million for purchases of property and equipment. Net cash used in investing activities in 2015 was $42.1 million consisting of net purchases of investments of $38.7 million and $3.4 million for purchases of property and equipment. Net cash used in investing activities in 2014 was $1.0 million for purchases of property and equipment.

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Net Cash Provided by Financing Activities

Net cash provided by financing activities in 2016 was $0.8 million, consisting of proceeds from common stock purchases under our employee stock purchase plan and from the exercise of stock options. Net cash provided by financing activities in 2015 was $81.3 million, consisting of net proceeds from the IPO of approximately $81.0 million and proceeds from the exercise of stock options. Net cash provided by financing activities in 2014 was $5.6 million, consisting of borrowings under our credit facility of $5.0 million and proceeds from the exercise of stock options of $0.6 million.

Credit Facility

We have a credit facility with Oxford Finance LLC under the terms of an amended and restated loan and security agreement, which was amended most recently in February 2017. Under the credit facility, we could borrow up to a total of $25.0 million in three tranches at a fixed interest rate of 9.40%. The first tranche of $15.0 million was borrowed in December 2013, a portion of which was used to refinance the $7.5 million previously outstanding under the credit facility. The second tranche of up to $5.0 million was available through December 31, 2014, of which all was borrowed. The third tranche of up to $5.0 million was available at any time through December 31, 2015, subject to certain trailing six-month revenue milestones. Although the specified revenue milestones for the third tranche were achieved, we elected not to borrow the additional funds. The credit facility matures and all amounts borrowed thereunder become due and payable on December 1, 2018. As a result of achieving certain funding and revenue milestones provided for in the credit facility in December 2015, we were permitted to extend the interest-only period of the credit facility through January 2017. In February 2017, we entered into an amendment to the amended and restated loan and security agreement to allow principal payment due on February 1, 2017 and March 1, 2017 to be instead paid on March 15, 2017. Accordingly, on March 15, 2017, we will make one principal and interest payment of $1.8 million and beginning on, April 1, 2017, make 21 equal monthly payment of principal and interest in the amount of approximately $1.0 million each.

In addition to the principal and interest payments under the credit facility, we are required to make a final payment fee of 7.15% on all amounts outstanding, which is being accrued over the credit facility term and will be due at the earlier of maturity or prepayment. If we repay the amounts borrowed under the credit facility prior to maturity, we will also be required to make a prepayment fee equal to 0.75% with respect to the principal amount that is prepaid.

Our obligations under the credit facility are secured by a first priority security interest in substantially all of our assets, other than our intellectual property. We have agreed not to pledge or otherwise encumber our intellectual property assets, except for permitted liens, as such terms are defined in the credit facility and except as otherwise provided for in the credit facility. The credit facility contains no financial covenants, and we were in compliance with its affirmative and restrictive covenants as of December 31, 2016.

As of December 31, 2016 and 2015, we had $20.0 million of debt outstanding and no unused credit under the credit facility.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet partnerships, arrangements or other relationships with unconsolidated entities or others, often referred to as structured finance or special-purpose entities that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Contractual Obligations

The following table sets forth, as of December 31, 2016, our contractual obligations due by period.

 

 

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In June 2016, we entered into an Amended and Restated Fiagon NA Distribution Agreement, or the Distribution Agreement, with Fiagon NA Corporation in which we were granted exclusive distribution rights in the United States and Canada for Fiagon Image Guidance Systems, or Fiagon IGS, and certain components, parts and related ancillary products i) to hospitals, ii) to ENT physicians in the office, clinic, and surgery centers, and iii) under ENT healthcare system contracts. The terms of the Distribution Agreement require us to purchase minimum quantities of Fiagon IGS and certain other disposable products through August 9, 2020 in order for us to retain exclusive distribution rights.

Interest Rate Risk

Interest rate fluctuations have not had a material impact on our results of operations. Our cash and cash equivalents include cash in readily available checking and money market accounts. Because our cash equivalents are primarily short-term in duration, we believe that our exposure to interest rate risk is not significant and a 100 basis point movement in market interest rates would not have a significant impact on the total value of our cash and cash equivalents. Additionally, the interest rate on our credit facility is fixed and not subject to changes in market interest rates.

Inflation

Inflationary factors, such as increases in our cost of goods sold and selling and operating expenses, may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain and increase our gross margin and selling and marketing and operating expenses as a percentage of our revenue if the selling prices of our products do not increase as much or more than these increased costs.

Credit Risk

As of December 31, 2016, our cash and cash equivalents were maintained with financial institutions in the United States and United Kingdom, and our current deposits at certain of these institutions are likely in excess of insured limits.

Our accounts receivable primarily relate to revenue from the sale of our XprESS family of products and other products to hospitals, ASCs and physician offices. For the year ended December 31, 2016, no single customer represented more than 5% of our revenue.

Foreign Currency Exchange Rate Risk

While our business is primarily conducted in U.S. dollars, our sales in Europe are conducted in U.S. dollars and British pounds. We believe that our exposure to foreign currency risk is not materially significant and a hypothetical 100 basis point movement in the U.S. dollar would not have a material impact on our results of operations, financial position or cash flows. As our sales in currencies other than the U.S. dollar increase, our exposure to foreign currency fluctuations may increase, and we may choose to hedge our exposure in the future.

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ENTELLUS MEDICAL, INC.

Index to Consolidated Financial Statements

 

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders of

Entellus Medical, Inc.

We have audited the accompanying consolidated balance sheets of Entellus Medical, Inc. (a Delaware corporation) and subsidiary (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2016. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Entellus Medical, Inc. and subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ Grant Thornton LLP

Minneapolis, Minnesota

February 22, 2017

 

 

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ENTELLUS MEDICAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ENTELLUS MEDICAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except per share data)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ENTELLUS MEDICAL, INC.

CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands)

 

 

The accompanying notes are an integral part of these consolidated financial statements

 

 

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ENTELLUS MEDICAL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ENTELLUS MEDICAL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE A – ORGANIZATION

Nature of Business

Entellus Medical, Inc. (the “Company”) was incorporated in Minnesota in April 2006 and was reincorporated in Delaware in August 2006. The Company is focused on delivering superior patient and physician experiences through products designed for the minimally invasive treatment of chronic and recurrent sinusitis in both adult and pediatric patients. The Company’s platform of products provides effective and easy-to-use solutions designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. The Company’s three core product lines, XprESS™ Multi-Sinus Dilation Systems, MiniFESS™ Surgical Instruments, and FocESS™ Imaging & Navigation, are designed to enable ear, nose and throat (“ENT”) physicians to conveniently and comfortably perform a broad range of procedures in the ENT physician office and simplify operating room-based treatment. The Company currently sells product through its direct sales force in the United States and United Kingdom and in a limited number of additional countries through international distributors. The Company operates in one reporting segment.

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Initial Public Offering

In February 2015, the Company completed its initial public offering (“IPO”) by issuing 5.3 million shares of common stock at an offering price of $17.00 per share, for net proceeds to the Company of approximately $81.0 million, after deducting underwriting discounts and commissions and offering expenses payable by the Company. In connection with the IPO, the Company’s outstanding shares of convertible preferred stock were automatically converted into an aggregate of 11.4 million shares of common stock and warrants exercisable for convertible preferred stock were automatically converted into warrants to purchase up to an aggregate of less than 0.1 million shares of common stock, resulting in the reclassification of the related redeemable convertible preferred stock warrant liability of $0.6 million to additional paid-in-capital.

1-for-4 Reverse Stock Split

In connection with the IPO, the Company’s board of directors and stockholders approved a reverse stock split of the Company’s common stock on a 1-for-4 basis. The reverse stock split became effective on January 12, 2015. The par value of the common stock was not adjusted as a result of the reverse stock split. Adjustments corresponding to the reverse stock split were made to the ratio at which the convertible preferred stock converted into common stock immediately prior to the closing of the IPO. Accordingly, all share and per share amounts for all periods presented in these consolidated financial statements and notes thereto have been adjusted retroactively, where applicable, to reflect the reverse stock split and adjustment of the preferred stock’s conversion ratios.

Basis of Preparation

The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).

JOBS Act Accounting Election

As an emerging growth company under the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), the Company is eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. The Company has elected to take advantage of the extended transition period for adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies.

Principles of Consolidation

The consolidated financial statements include the accounts of Entellus Medical, Inc., and its wholly owned subsidiary. All significant intercompany transactions and accounts have been eliminated.

 

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

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Foreign Currency Translation

Sales and expenses denominated in foreign currencies are translated at average exchange rates in effect throughout the year. Assets and liabilities of foreign operations are translated at period-end exchange rates with the impacts of foreign currency translation recognized to foreign currency translation adjustment, a component of accumulated other comprehensive loss. Foreign currency transaction gains and losses are included in other income (expense) in the consolidated statements of operations and comprehensive loss.

Fair Value of Financial Instruments

As of December 31, 2016 and 2015, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximated their estimated fair value because of the short-term nature of the financial instruments. The Company determines the fair value of its assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. A fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, is used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1). The next highest priority is based on quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar assets or liabilities in non-active markets or other observable inputs (Level 2). The lowest priority is given to unobservable inputs (Level 3).

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an initial maturity of 90 days or less to be cash equivalents. At December 31, 2016 and 2015, cash equivalents consisted of money market funds recorded at fair value and federal and corporate debt securities recorded at amortized costs. There were no investments in marketable securities at December 31, 2016 and $16.7 million were classified as cash equivalents as of December 31, 2015. The Company maintains cash and cash equivalents in bank accounts which, at times, may exceed Federal Deposit Insurance Corporation (“FDIC”) limits. The Company has not experienced any losses from maintaining balances in excess of FDIC limits.

Short-Term Investments

Short-term investments represent holdings of marketable securities in accordance with the Company’s investment policy and cash management strategy. Short-term investments are classified as available-for-sale and mature within 12 months from the balance sheet date. Investments with maturity dates greater than one year from the balance sheet date are classified as long-term investments. At the time that the maturity dates of these investments become one year or less, the securities are reclassified to short-term investments. The Company’s investments are recorded at fair value, with any unrealized gains and losses reported as a component of stockholders’ equity (deficit) until realized or until a determination is made that an other-than-temporary decline in market value has occurred. The cost of investments sold is determined based on the specific identification method and any realized gains or losses on the sale of investments are reflected as a component of interest income or expense. These investments are deemed Level 2 assets under the fair value hierarchy as their fair value is determined under a market approach using valuation models that utilize observable inputs, including maturity date, issue date, settlements date, and current interest rates.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash equivalents and accounts receivable. The Company generally does not require collateral and losses on accounts receivable have historically been within management’s expectations.

The Company’s investment policy limits investments, when held, to certain types of debt securities issued by the U.S. government, its agencies, and institutions with investment-grade credit ratings, as well as corporate debt or commercial paper issued by the highest quality financial and non-financial companies, and places restrictions on maturities and concentration by type and issuer. The Company is exposed to credit risk in the event of a default by the financial institutions holding its cash and equivalents and issuers of debt securities to the extent recorded on the consolidated balance sheets.

Accounts Receivable

Credit is granted to customers in the normal course of business, generally without collateral or any other security to support amounts due. Accounts are considered past due generally after 30 days. The Company maintains an allowance for doubtful accounts for estimated losses in the collection of accounts receivable. The Company makes estimates regarding the future ability of its customers to make required payments based on historical credit experience, delinquency and expected future trends. The Company will write off accounts receivable when it determines that the accounts receivable are uncollectible, typically upon customer

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bankruptcy or the customer’s non-response to continued collection efforts. The allowance for doubtful accounts was $0.2 million and $0.1 million as of December 31, 2016 and 2015, respectively. The Company also maintains an allowance for sales returns based on historical experience and evaluation of current sales and returns trends. The allowance for sales returns was $0.2 million and $0.3 million as of December 31, 2016 and 2015, respectively.

Inventories

Inventories are stated at the lower of cost to purchase or manufacture the inventory or the net realizable value of such inventory. Cost is determined using the standard cost method which approximates the first-in, first-out basis. Market value is determined as the lower of replacement cost or net realizable value. The Company regularly reviews inventory quantities in consideration of actual loss experiences, projected future demand, and remaining shelf life to record a provision for excess and obsolete inventory when appropriate.

Property and Equipment

Property and equipment are recorded at cost. Depreciation of furniture, office, computer and laboratory equipment is calculated on a straight-line basis over the asset’s estimated useful life, which ranges from two to ten years. Tooling and molds are depreciated on a straight-line basis over three to five years. Leasehold improvements are amortized on a straight-line basis over the shorter of the remaining life of the lease or the useful life of the asset. Repair and maintenance expenditures are charged to earnings as incurred. Major repairs and maintenance expenditures that extend useful lives of property and equipment are capitalized.

Deferred Offering Costs

Deferred offering costs, primarily consisting of legal, accounting and other direct fees and costs relating to public offerings, are capitalized. As of December 31, 2016, $0.3 million of deferred offering costs were capitalized in other non-current assets on the consolidated balance sheet related to the public offering completed in the first quarter of 2017. As of December 31, 2015, there were no deferred offering costs capitalized.  

Business Combination

On June 29, 2016, the Company acquired and entered into an exclusive license for the XeroGel™ assets with CogENT Therapeutics, LLC for $11.0 million in cash (the “XeroGel acquisition”). The excess of purchase consideration over the fair value of the net assets acquired was allocated to goodwill, which is deductible for U.S. income tax purposes. Given the timing of the XeroGel acquisition, the estimated fair value of the net assets acquired as of June 30, 2016 was preliminary and subject to change. While the Company uses its best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired at the acquisition date, its estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, the Company has recorded adjustments to the assets acquired as follows:

 

 

The Company may continue to assess and refine the purchase price allocation through the end of the measurement period, which, in accordance with applicable accounting standards, should not exceed one year from the date of the XeroGel acquisition. The intangible assets and goodwill acquired are considered Level 3 financial assets.

The Company incurred transaction costs in connection with the acquisition of approximately $0.3 million for the year ended December 31, 2016, which are included in general and administrative expenses.

Under the terms of the XeroGel acquisition agreements, the Company became the manufacturer of XeroGel nasal packing material and will continue to market and sell XeroGel nasal packing material to hospitals, offices and ambulatory surgery centers. Prior to the transaction, the Company was the exclusive distributor of XeroGel nasal packing material in the United States. The distribution agreement between the two parties was terminated in connection with the transaction. As a result of the XeroGel acquisition, the Company began recognizing all XeroGel revenue on a gross basis effective June 29, 2016.

The Company has concluded that the XeroGel acquisition was not material for purposes of including pro forma information in this report and therefore has not provided any such information herein.

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Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Intangible assets are recorded at their estimated fair value at the date of acquisition. In the year following the period in which identified intangible assets become fully amortized, the fully amortized balances are removed from the gross asset and accumulated amortization amounts. Goodwill is not amortized, but is instead subject to impairment testing. Intangible assets with finite lives are amortized using a straight-line method over their respective useful lives.

Goodwill Impairment Policy

The Company chose November 1 to assess its annual goodwill for any impairment in order to closely align with the timing of its annual planning process. On an annual basis, or more frequently upon the occurrence of certain events, the Company tests for goodwill impairment using a three-step process. The first step of the goodwill impairment test is to perform a qualitative assessment before calculating the fair value of the reporting unit. If based on the qualitative factors, it is more likely than not that the fair value of the reporting unit is less than the carrying amount of the reporting unit, the Company is then required to perform the next step of the goodwill impairment test. The second step is to identify a potential impairment by comparing the calculated fair value of a reporting unit with its carrying amount. The fair value of a reporting unit is determined based on a discounted cash flow analysis and further analyzed using other methods of valuation. A discounted cash flow analysis requires the Company to make various assumptions, including assumptions about future cash flows, growth rates and discount rates. The assumptions about future cash flows and growth rates are based on the Company’s long-term projections. In addition, an assumed terminal value is used to project future cash flows beyond base years. Assumptions used in the Company’s impairment testing are consistent with the Company’s internal forecasts and operating plans. The Company’s discount rate is based on its debt and equity balances, adjusted for current market conditions and investor expectations of return on its equity. If the fair value of a reporting unit exceeds its carrying amount, there is no impairment. If the calculated fair value is less than the carrying value, the third step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with its carrying amount. To the extent the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, a write-down of the reporting unit’s goodwill would be necessary.

The Company has performed a qualitative assessment of the reporting unit and determined that it was not more likely than not that the fair value of the reporting unit was less than the carrying amount of the reporting unit; therefore, the Company was not required to perform the next step of the goodwill impairment test. For the year ended December 31, 2016 no goodwill impairment was identified. The Company did not have any goodwill on its consolidated balance sheet prior to the XeroGel acquisition.  

Impairment of Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Company has not recorded impairment charges on long-lived assets for the periods presented in these consolidated financial statements.

Deferred Rent

The Company accounts for rent expense related to operating leases by determining total minimum rent payments on the leases over their respective periods and recognizing the rent expense on a straight-line basis. The difference between the actual amount paid and the amount recorded as rent expense in each period presented is recorded as an adjustment to other non-current liabilities in the consolidated balance sheet.

Debt Issuance and Debt Discount

Debt issuance costs and discounts are recorded as a reduction of long-term debt. Amortization of debt issuance costs and the debt discount is calculated using the effective interest method over the term of the debt and is recorded in interest expense in the accompanying consolidated statements of operations and comprehensive loss.

Revenue Recognition

The Company recognizes revenue when persuasive evidence of a sales arrangement exists, delivery of goods has occurred through the transfer of title and risks and rewards of ownership, the selling price is fixed or determinable and collectability is reasonably assured. Revenue is reported net of the allowance for sales returns. Taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between a seller and a customer are not recorded as revenue.

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The Company entered into a distribution agreement with CogENT Therapeutics, LLC, (“CogENT”) in September 2013 and was an exclusive distributor of XeroGel nasal packing material in the United States from October 2013 to June 2016. For products shipped from the CogENT warehouse to customers, CogENT was responsible for all manufacturing, order fulfillment, quality and regulatory requirements of the product. For these direct shipment orders, the Company did not take title to CogENT products prior to products being ordered by customers or in the event CogENT products are returned by customers. The Company recorded transactions under this arrangement on a net basis based on the difference between the amounts billed to customers less the amounts paid to CogENT for the XeroGel product.

In June 2016, the Company acquired and entered into an exclusive license for the XeroGel assets with CogENT for $11.0 million in cash. Under the terms of the agreements, the Company now manufactures and sells XeroGel nasal packing material to hospitals, offices and ASCs. The distribution agreement between the two parties was terminated in connection with the transaction. As a result of the XeroGel acquisition, the Company began recognizing all XeroGel revenue on a gross basis effective June 29, 2016.

The Company’s net revenue from XeroGel sales for the period January 1, 2016 through June 28, 2016 and the years ended December 31, 2015 and 2014 were approximately $0.7 million, $1.2 million and $0.8 million, respectively. The Company records transactions on a gross basis for XeroGel product for which is takes title, ships the product and handles returns. The amounts of revenue recorded on a gross basis from XeroGel sales for the period from January 1, 2016 through June 28, 2016 and the years ended December 31, 2015 and 2014 were approximately $0.1 million, $0.2 million and $0.1 million, respectively.  

Shipping and Handling

Shipping and handling costs charged to customers are included as a component of revenue and related costs are included in costs of goods sold.

Cost of Goods Sold

Cost of goods sold consists primarily of manufacturing overhead costs, material costs and direct labor. A significant portion of the Company’s cost of goods sold currently consists of manufacturing overhead costs. These overhead costs include the cost of quality assurance, material procurement, inventory control, facilities, equipment, operations supervision and management, depreciation expense for production equipment, shipping costs and royalty expense payable in connection with sales of certain products. For those products the Company sells as a distributor, cost of goods sold consists primarily of transfer price.

Research and Development Costs

Research and development expenses consist primarily of engineering, product development, clinical and regulatory affairs, consulting services, materials, depreciation and other costs associated with products and technologies in development. These expenses include employee and non-employee compensation, including stock-based compensation, supplies, materials, consulting, related travel expenses and facility costs. Clinical expenses include clinical trial design, clinical site reimbursement, data management and travel expenses, and the cost of manufacturing products for clinical trials. Expenditures for research and development activities are charged to operations as incurred.

Advertising Expense

Expenditures for advertising are charged to operations as incurred. Advertising expenses were $1.2 million, $1.1 million and $0.6 million during the years ended December 31, 2016, 2015 and 2014, respectively.

 

Common Stock Valuation and Stock-based Compensation

Prior to the IPO, the Company maintained the Entellus Medical, Inc. 2006 Stock Incentive Plan (the “2006 Plan”) to provide long-term incentives for employees, consultants and members of the board of directors. The 2006 Plan allowed for the issuance of non-statutory and incentive stock options to employees and non-statutory stock options to employees, consultants and non-employee directors. In connection with the IPO, the 2006 Plan terminated, and the Company adopted a new equity incentive plan, the Entellus Medical, Inc. 2015 Incentive Award Plan (the “2015 Plan”).

The Company is required to determine the fair value of equity incentive awards and recognize compensation expense for all equity incentive awards made to employees and directors, including employee stock options. The Company also determines the fair value of non-statutory stock options issued to consultants based on the fair value of the consultant’s commitment at the date of grant. Such expense is recognized over the requisite service period. In addition, stock-based compensation expense recognized in the consolidated statements of operations and comprehensive loss is based on awards expected to vest; and therefore, the amount of expense has been reduced for estimated forfeitures. The Company uses the straight-line method for expense attribution, except for awards issued with performance-based conditions which require an accelerated attribution method over the requisite performance and service periods.

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Under the applicable accounting guidance for equity incentive awards issued to non-employees, the date at which the fair value of such awards is measured is equal to the earlier of: 1) the date at which a commitment for performance by the counterparty to earn the equity instrument is reached; or 2) the date at which the counterparty’s performance is complete. The Company recognizes stock-based compensation expense for the fair value of the vested portion of the non-employee awards in the consolidated statements of operations and comprehensive loss.

The valuation model used for calculating the fair value of awards for stock-based compensation expense is the Black-Scholes option-pricing model (the “Black-Scholes model”). The Black-Scholes model requires the Company to make assumptions and judgments about the variables used in the calculation, including the expected term (weighted average period of time that the options granted are expected to be outstanding), the volatility of common stock and an assumed risk-free interest rate. The Company uses the “simplified method” to determine the expected term of the stock option. Volatility is based on an average of the historical volatilities of the common stock of publicly-traded companies with characteristics similar to those of the Company. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected term of the option. The expected dividend assumption is based on the Company’s history of not paying dividends and its expectation that it will not declare dividends for the foreseeable future. Potential forfeitures of awards are estimated based on the Company’s historical forfeiture experience. The estimate of forfeitures will be adjusted over the service period to the extent that actual forfeitures differ, or are expected to differ, from prior estimates.

Convertible Preferred Stock Warrant Liability

For a warrant classified as a derivative liability, the fair value of that warrant is recorded on the consolidated balance sheet when granted and adjusted to fair value at each financial reporting date. The changes in the fair value of the warrants are recorded in the consolidated statements of operations and comprehensive loss as a component of interest income or expense as appropriate. The warrants represent financial instruments that were categorized as Level 3.

The Company issued warrants to purchase shares of convertible preferred stock in connection with the Company’s entry into its original credit facility in October 2012. The warrants were recorded at fair value using the Black-Scholes model. The fair value of these warrants was remeasured at each financial reporting period with any changes in fair value being recognized as a component of other income (expense) in the consolidated statements of operations and comprehensive loss. In connection with the IPO, in January 2015, the Company performed the final remeasurement of the warrant liability. There were costs of $0.4 million during the year ended December 31, 2015 recorded as interest expense from the final remeasurement.

Upon the closing of the IPO, warrants to purchase shares of convertible preferred stock automatically converted into warrants to purchase shares of common stock. The Company reclassified the warrant liability to additional paid-in capital, as the warrants met the definition of an equity instrument, in the amount of $0.6 million during the year ended December 31, 2015.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

 

The Company applies a recognition threshold for income tax positions taken or expected to be taken on a tax return. The impact of an uncertain tax position taken or expected to be taken on an income tax return are recognized in the consolidated financial statements at the largest amount that is more-likely-than not to be sustained upon audit by the relevant taxing authority. An uncertain tax position is not recognized in the consolidated financial statements unless it is more-likely-than not of being sustained. The Company has no reserve for unrecognized tax benefits at December 31, 2016 and 2015; and accordingly, there is no interest or penalties recorded on the consolidated balance sheet for such reserves. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and the appropriate state income taxing authorities for 2006 through 2016.

 

As of December 31, 2016, the Company had a valuation allowance of $51.9 million recorded against its deferred tax assets. The Company will maintain this valuation allowance until an appropriate level of profitability is sustained or the Company is able to develop tax planning strategies that enable it to conclude that it is more likely than not that its deferred tax assets are realizable. As of December 31, 2016, the Company had a deferred tax liability relating to indefinite-lived goodwill. This deferred tax liability cannot be used as a future source of taxable income because of the indefinite nature of the asset and therefore cannot be used to offset the deferred tax assets that require a valuation allowance.

Net Loss per Share

Basic net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of

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shares of common stock and dilutive potential shares of common stock outstanding during the period. Because the Company has reported a net loss for all periods presented, diluted net loss per share is the same as basic net loss per share for those periods as all potentially dilutive shares consisting of convertible preferred stock, stock options and warrants were antidilutive in those periods.

The Company allocates no loss to participating securities because they have no contractual obligation to share in the losses of the Company. The shares of the Company’s convertible preferred stock participated in any dividends declared by the Company and were therefore considered to be participating securities.

Comprehensive Loss

Comprehensive loss consists of net loss, changes in unrealized gains and losses on available-for-sale marketable securities and changes in unrealized translation gains and losses. Accumulated other comprehensive income is presented in the accompanying consolidated balance sheets, when applicable.

Segment, Geographical and Customer Concentration

The Company operates in one segment. No single customer accounted or geographic area for more than 10% of its revenue during the years ended December 31, 2016, 2015 and 2014.

Recent Accounting Pronouncements

In May 2014, the Financial and Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. This standard will eliminate the transaction and industry specific revenue recognition guidance under current U.S. GAAP and replace it with a principles-based approach for determining revenue recognition. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606 – Revenue from Contracts with Customers, to clarify the Codification or to correct unintended application of guidance. The new guidance is effective for annual and interim periods beginning after December 15, 2018. ASU 2014-09 allows for full retrospective adoption applied to all periods presented or modified retrospective adoption with the cumulative effect of initially applying the standard recognized at the date of initial application. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations – Reporting Revenue Gross versus Net. This ASU clarifies the revenue recognition implementation guidance for preparers on certain aspects of principal versus agent consideration. The amendments in this ASU are effective for private companies and emerging growth companies beginning after December 15, 2018. The adoption of ASU 2016-08 will be concurrently adopted with the adoption of ASU 2014-09. The Company plans to adopt the new guidance beginning January 1, 2019.

The Company has performed a review of the requirements of the new guidance and has identified which of its revenue streams will be within the scope of ASU 2014-09.  The Company is working through an adoption plan which includes a review of customer contracts, applying the five-step model of the new standard, to each revenue stream and comparing the results to its current accounting; an evaluation of the method of adoption; and assessing changes that might be necessary to information technology systems, processes, and internal controls to capture new data and address changes in financial reporting. Because of the nature of the work that remains, at this time the Company is unable to reasonably estimate the impact of adoption on its consolidated financial statements. 

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance, which changes the presentation of debt issuance costs in financial statements. Under ASU 2015-03, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. ASU 2015-03 is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. A company should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, a company is required to comply with the applicable disclosures for a change in an accounting principle. The guidance only affects the presentation of debt issuance costs in the balance sheet and has no impact on results of operations. The Company applied ASU 2015-03 on January 1, 2016 and reclassified debt issuance costs from long-term assets to long-term debt. Debt issuance costs included in long-term debt in the accompanying consolidated financial statements were $0.1 million and $0.2 million at December 31, 2016 and December 31, 2015, respectively.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. The Company does not expect that adoption of ASU 2016-01 will have a significant impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases, which requires that lease arrangements longer than twelve months result in an entity recognizing an asset and liability. The updated guidance in this ASU are effective for private companies and emerging growth companies beginning after December 15, 2019. The Company is currently evaluating the impact of the updated guidance on its consolidated financial statements.

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In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation, which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, the estimation of forfeitures, shares withheld for taxes and classification of shares withheld for taxes on the statement of cash flows. As part of the adoption of this guidance the Company has elected to account for forfeitures of share-based awards as they occur.  The Company adopted ASU 2016-09 on January 1, 2017 and there was not a material impact on the consolidated financial statements.  

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2020; the ASU allows for early adoption as of the beginning of an interim or annual reporting period beginning after December 15, 2018. The Company is currently assessing the impact that this standard will have on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statements of Cash Flows – Classifications of Certain Cash Receipts and Cash Payments to clarify how companies present and classify certain cash receipts and cash payments in the statement of cash flows. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018; the ASU allows for early adoption. The Company does not believe that adoption of ASU 2016-15 will have a significant impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations – Clarifying the Definition of a Business, to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or dispositions) of assets or businesses. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018, the ASU allows for early adoption. The Company does not believe that adoption of ASU 2017-01 will have a significant impact on its consolidated financial statements.

NOTE C – COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS

Inventories

 

 

Property and Equipment

 

 

Depreciation and amortization expense was $1.7 million, $1.0 million and $0.6 million during the years ended December 31, 2016, 2015 and 2014, respectively.

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Intangible Assets

 

 

In connection with the XeroGel acquisition, the Company acquired the technology-based intangible assets described in the above table and the XeroGel trade name. The technologies are amortized over a useful life of approximately 14 years, based on the remaining useful life of the licenses acquired as management plans to fully utilize the technologies over the full useful life, and the trade name is amortized over a useful life of 14 years. Amortization expense was $0.4 million during the year ended December 31, 2016.  

Accrued Expenses

 

 

Interest Expense

 

 

NOTE D – LIQUIDITY AND BUSINESS RISKS

As of December 31, 2016 and 2015, the Company had cash and cash equivalents of $21.4 million and $28.5 million and an accumulated deficit of $150.8 million and $122.1 million, respectively. In February 2015, the Company completed its IPO by issuing 5.3 million shares of common stock at an offering price of $17.00 per share, for net proceeds to the Company of approximately $81.0 million after deducting underwriting discounts and commissions and offering expenses payable by the Company.

In the first quarter of 2017, the Company completed a public offering of shares of its common stock, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain existing stockholders of the Company also sold approximately 1.2 million shares of common stock in the offering. The Company received estimated net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions and offering expenses payable by the Company. The Company did not receive any proceeds from the sale of shares by the existing selling stockholders.

Prior to the public offerings, the Company financed its operations with a combination of revenue, private placements of convertible preferred securities and amounts borrowed under its credit facility. The Company expects that its cash and cash equivalents, short-term investments and anticipated revenue will be sufficient to fund its operations through at least the next twenty-four months from the date of this Annual Report on Form 10-K.

NOTE E – SHORT-TERM INVESTMENTS

The Company determines the appropriate classification of its investments at the time of purchase and revaluates such determinations at each balance sheet date. Marketable securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity.

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Marketable securities for which the Company does not have the intent or ability to hold to maturity are classified as available-for-sale. Marketable securities classified as available-for-sale are carried at fair market value, with the unrealized gains and losses included in the determination of comprehensive income and reported in stockholders’ equity.

The following is a summary of the available-for-sale investments by type of instrument, which are included in short-term investments in the consolidated balance sheet as of December 31, 2016 and December 31, 2015.

 

 

 

Based on an evaluation of securities that have been in a loss position, the Company did not recognize any other-than-temporary impairment charges during the years ended December 31, 2016 and December 31, 2015. The Company considered various factors, including a credit and liquidity assessment of the underlying securities and the Company’s intent and ability to hold the underlying securities until the estimated date of recovery of its amortized cost. As of December 31, 2016 and December 31, 2015, available-for-sale maturities as noted in the table above mature in one year or less.

NOTE F – FAIR VALUE MEASUREMENTS

As of December 31, 2016 and 2015, the carrying amounts of cash and cash equivalents, receivables, accounts payable and accrued expenses approximated their estimated fair values because of the short-term nature of these financial instruments.

Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three categories:

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Short-term Investments

The following is a summary of available-for-sale investments by type of instrument measured at fair value on a recurring basis at December 31, 2016 and December 31, 2015.

 

 

 

 

There were no transfers in or out of Level 1, Level 2 or Level 3 fair value measurement during the years ended December 31, 2016 and December 31, 2015. The Company has not experienced any significant realized gains or losses on its investments in the periods presented in the consolidated statements of operations and comprehensive loss.

NOTE G – DEBT

The Company has a credit facility (the “credit facility”) with Oxford Finance LLC under the terms of an amended and restated loan and security agreement, which was amended most recently in February 2017.      

Under the credit facility, the Company can borrow up to a total of $25.0 million in three tranches at a fixed rate of 9.40%. The first tranche of $15.0 million, including the refinance of $7.5 million previously outstanding, was borrowed in December 2013. In connection with the funding of the first tranche, the Company paid a prorated final payment fee on the original credit facility of $0.1 million. The second tranche of up to $5.0 million was available through December 31, 2014, all of which was borrowed during the three months ended December 31, 2014. The third tranche of up to $5.0 million was available at any time through December 31, 2015, subject to certain six-month revenue milestones. Although the specified revenue milestones for the third tranche were achieved, the Company elected not to borrow additional funds. The credit facility matures and all amounts borrowed thereunder are due on December 1, 2018. As a result of achieving certain funding and revenue milestones provided for in the credit facility in December 2015, the Company was permitted to extend the interest-only period through January 2017. In February 2017, the Company entered into an amendment to the amended and restated loan and security agreement to allow principal payments due on February 1, 2017 and March 1, 2017 to be instead paid on March 15, 2017. Accordingly, on March 15, 2017, one principal and interest payment of $1.8 million is due and beginning on April 1, 2017 21 equal monthly payment of principal and interest in the amount of approximately $1.0 million each will become due.

In addition to the principal and interest payments, under the credit facility the Company is required to pay a final payment fee of 7.15% on all amounts outstanding, which is being accrued over the credit facility term and will be due at the earlier of maturity or prepayment. If the Company repays the amounts borrowed under the credit facility prior to maturity, the Company will also be required to pay a prepayment fee equal to 0.75%, with respect to the principal amount that is prepaid.

The credit facility includes affirmative and restrictive covenants and events of default, including the following events of default: payment defaults, breaches of covenants, judgment defaults, cross defaults to certain other contracts, certain events with respect to governmental approvals if such events could cause a material adverse change, a material impairment in the perfection or priority of the lender’s security interest or in the value of the collateral, a material adverse change in the business, operations or condition of the Company or any of its subsidiaries and a material impairment of the prospect of repayment of the credit facility. Upon the occurrence of an event of default, a default increase in the interest rate of an additional 5.00% could be applied to the outstanding loan balance and the lender could declare all outstanding obligations immediately due and payable and take such other actions as set forth in the amended and restated loan and security agreement.

The Company’s obligations under the credit facility are secured by a first priority security interest in substantially all of its assets, other than its intellectual property. There are no financial covenants contained in the credit facility and the Company is in compliance with the affirmative and restrictive covenants as of December 31, 2016.

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As of December 31, 2016 and 2015, the Company had $20.0 million of debt outstanding and no unused availability under the credit facility.

In connection with the original credit facility and in conjunction with the close of the first tranche in October 2012, the Company issued the lender warrants to purchase 0.2 million shares of Series E Preferred Stock at an exercise price of $1.9594 per share. In connection with the IPO in February 2015, the warrants became exercisable for up to 38 shares of the Company’s common stock with an exercise price of $7.84 per share. Each warrant may be exercised on a cashless basis in whole or in part. Using the Black-Scholes valuation model, management estimated the fair value of these warrants to be approximately $0.1 million at issuance of the warrant. The following assumptions were used to estimate the fair value: expected volatility of 45.00%, risk-free interest rate of 1.64%, and expected term of 10 years. These warrants were considered to be costs incurred as part of the credit facility and were recorded as a debt discount which was offset against the loan, and were to be amortized over the life of the original credit facility based on the effective interest method to interest expense. In connection with one of the amendments to the amended and restated loan and security agreement, the Company amortized the remaining debt discount to interest expense. No stock warrants were issued in conjunction with such amendment.

Based on a 22-month amortization period, the Company’s principal payments are due under the amended credit facility as follows for the years ending December 31:

 

 

At December 31, 2016 and 2015, the carrying amount of debt approximated fair value because the fixed interest rate approximates current market rates of interest available in the market. The fair value of the Company’s debt is considered a Level 3 measurement.

NOTE H– STOCKHOLDERS’ EQUITY

Preferred Stock

The Company’s amended and restated certificate of incorporation authorizes 10.0 million shares of preferred stock. As of December 31, 2016 and 2015, no shares of preferred stock were outstanding.

Common Stock

In May 2014, the Company amended its certificate of incorporation to increase the authorized number of shares of common stock available for issuance from 57.0 million to 57.6 million shares of $0.001 par value common stock. In December 2014, the Company further amended its Certificate of Incorporation to increase the authorized number of shares of common stock available for issuance to 62.3 million shares. In connection with the IPO, the Company further amended and restated its certificate of incorporation to increase the authorized number of shares of common stock available for issuance to 200.0 million shares of common stock.

Stockholders are generally entitled to one vote for each share of common stock held on all matters submitted to a vote of the stockholders and do not have any cumulative voting rights. Stockholders are entitled to receive proportionally any dividends declared by the Company’s Board of Directors, subject to any preferential dividend rights of any then outstanding preferred stock.

In the event of the Company’s liquidation or dissolution, stockholders are entitled to share ratably in all assets remaining after payment of all debts and other liabilities, subject to any preferential rights of any then outstanding preferred stock. Stockholders have no preemptive, subscription, redemption or conversion rights.

2006 Stock Incentive Plan

Under the 2006 Plan approved by the Company’s Board of Directors in August 2006, 3,541,308 shares of common stock were  reserved for issuance of incentive stock options (“ISOs”), non-statutory stock options (“NSOs”), stock bonuses and restricted stock to employees, officers, directors and consultants of the Company as of December 31, 2014. ISOs granted under the 2006 Plan generally vest ratably over a four-year vesting term and expire 10 years from the grant date. NSOs vest per the specific agreement and expire 10 years from the date of grant. At December 31, 2014, there were 23 shares available for issuance under the 2006 Plan. In connection with the IPO, the 2006 Plan terminated, and the Company adopted a new equity incentive plan, the 2015 Plan.

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2015 Incentive Award Plan

In December 2014, the Company’s Board of Directors adopted, and in January 2015, the Company’s stockholders approved, the 2015 Incentive Award Plan (“2015 Plan”). The 2015 Plan became effective on the effective date of the IPO, at which time the Company ceased making awards under the 2006 Plan. Under the 2015 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and certain other awards to individuals who are employees, officers, directors or consultants of the Company. Awards granted under the 2015 Plan generally vest equally over a four-year vesting term and expire 10 years from the grant date. A total of 1,345,570 shares of common stock were initially reserved for issuance under the 2015 Plan. In addition, the number of shares of common stock available for issuance under the 2015 Plan will be annually increased by an amount equal to the lesser of (A) 875,000 shares, (B) 4% of the outstanding shares of the Company’s common stock as of the last day of the Company’s immediately preceding fiscal year or, an amount determined by the Company’s Board of Directors. Furthermore, any shares subject to awards granted under the 2006 Plan which terminate, expire or lapse without the delivery of shares to the holder thereof become available under the 2015 Plan. In the first quarter of 2016, in accordance with this “evergreen” provision, the number of shares available under the 2015 Plan was increased in the amount of approximately 751,750 shares. As of December 31, 2016, 569,968 shares of common stock were available for issuance under the 2015 Plan.

A summary of the Company’s stock option activity and related information is as follows:

 

 

During the years ended December 31, 2016, 2015 and 2014, the aggregate pre-tax intrinsic value of options exercised was $1.3 million, $3.2 million and $4.2 million, respectively. The aggregate pre-tax intrinsic value was calculated as the difference between the exercise prices of the underlying options and the estimated fair value of the common stock on the date of exercise or December 31, 2016, 2015 and 2014, as applicable. During the years ended December 31, 2016, 2015 and 2014, the fair value of share vesting was $5.2 million, $2.5 million and $0.2 million. The total cash received upon the exercise of options was $0.2 million, $0.3 million and $0.6 million during the years ended December 31, 2016, 2015 and 2014, respectively.

During the year ended December 31, 2016, the Company issued time-based restricted stock units (“RSUs”) covering 11,771 shares of common stock that vest equally over four years at a per share weighted average fair value of $16.99. No RSUs vested or were forfeited during the year ended December 31, 2016. During the year ended December 31, 2016, the Company recognized less than $0.1 million of expense related to RSUs.

Early Exercise of Stock Options

Stock options granted under the 2006 Plan provide option holders the right to elect to exercise unvested options in exchange for restricted common stock. As of December 31, 2013, 41,174 shares remained unvested and subject to a repurchase right held by the Company at the original issuance price in the event the optionees’ service was voluntarily or involuntarily terminated. On October 31, 2014, a director resigned from the Board of Directors of the Company and the Company repurchased the remaining 27,894 unvested shares at a total purchase price of less than $0.1 million in November 2014.

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Reserved Shares

The Company is required to reserve and keep available out of its authorized but unissued shares of common stock a number of shares sufficient to satisfy the exercise of options granted and available for grant under the 2006 Plan and 2015 Plans.

The number of such shares of common stock reserved for the exercise and issuance of the following warrants, options, restricted stock units and shares outstanding as of December 31, 2016 and 2015, were as follows:

 

 

Employee Stock Purchase Plan

In December 2014, the Company’s Board of Directors adopted, and in January 2015 the Company’s stockholders approved, the Entellus Medical, Inc. 2015 Employee Stock Purchase Plan (“ESPP”). Under the ESPP, the Company has set two six-month offering periods during each calendar year, one beginning January 1 and ending on June 30, and the other beginning July 1 and ending on December 31, during which employees can choose to have up to 20% of their eligible compensation withheld to purchase less than 2,000 shares of the Company’s common stock during each offering period. The purchase price of the shares is 85% of the market price on the first or last trading day of the offering period, whichever is lower. A total of 200,000 shares of common stock were initially reserved for issuance under the ESPP. In addition, the number of shares of common stock available for issuance under the ESPP will be annually increased on the first day of each fiscal year during the term of the ESPP, beginning with the 2016 fiscal year, by an amount equal to the lesser of (A) 1% of the shares of the Company’s common stock outstanding on the date of the adoption of the plan or (B) a lesser amount determined by the Company’s Board of Directors. In the first quarter of 2016, in accordance with this “evergreen” provision, the number of shares available for grant under the ESPP increased in the amount of 16,488 shares, resulting in a total of 216,488 shares of common stock reserved for issuance under the ESPP. During the year ended December 31, 2016, the Company issued 35,962 shares of its common stock to participants under the ESPP. The Company recognized $0.2 million and zero in stock-based compensation expense related to the ESPP during the years ended December 31, 2016 and December 31, 2015, respectively.  

NOTE I – STOCK-BASED COMPENSATION EXPENSE

Stock-based compensation expense was reflected in the consolidated statement of operations and comprehensive loss for the years ended December 31, 2016, 2015 and 2014, as follows:

 

 

The amount of unearned stock-based compensation currently estimated to be expensed through the year 2020 related to unvested employee stock-based awards as of December 31, 2016, is approximately $14.1 million. The weighted average period over which the unearned stock-based compensation is expected to be recognized as of December 31, 2016, is approximately 2.5 years. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional stock-based awards.

The Company estimates the fair value of stock-based compensation on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model determines the fair value of stock-based awards based on the fair market value of the Company’s common stock on the date of grant and is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the fair market value of the Company’s common stock, volatility over the expected term of the awards and actual and projected employee stock option exercise behaviors. The Company has opted to use the “simplified method” for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option. Due to the Company’s limited operating history and company-specific historical and

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implied volatility data, the Company has based its estimate of expected volatility on the blended historical volatility of a group of similar companies that are publicly traded and the Company’s historical volatility. The historical volatility data was computed using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based awards. The Company will continue to analyze the historical stock price volatility and expected term assumptions as more historical data for the Company’s common stock becomes available. The risk-free rate assumption is based on the U.S. Treasury instruments with maturities similar to the expected term of the Company’s stock options. The expected dividend assumption is based on the Company’s history of not paying dividends and its expectation that it will not declare dividends for the foreseeable future.

As stock-based compensation expense recognized in the consolidated financial statements is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from estimates. Forfeitures are estimated based on estimated future employee turnover and historical experience.

The fair value of the options granted to employees and directors during the years ended December 31, 2016, 2015 and 2014, was estimated as of the grant date using the Black-Scholes model assuming the weighted average assumptions listed in the following table:

 

 

The fair value of the ESPP options granted to employees during the years ended December 31, 2016, 2015 and 2014, was estimated as of the grant date using the Black-Scholes model assuming the weighted average assumptions listed in the following table:

 

 

Performance-Based Options

Options issued during the year ended December 31, 2014 included grants to certain employees totaling 23 shares that contained vesting conditions contingent on the achievement of certain milestones. Assuming continued service by the employee, the option would vest immediately upon achievement of the performance criteria. At December 31, 2014, certain milestones were achieved and therefore five shares vested immediately. The Company recorded stock-based compensation expense totaling less than $0.1 million related to these options. The remaining 18 shares were cancelled. There were no performance-based option activity for the years ended December 31, 2016 and 2015.

NOTE J – INCOME TAXES

The components of loss before taxes for the years ended December 31, 2016, 2015 and 2014, consist of the following:

 

 

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Income tax expense differs from the amount computed by applying the statutory federal income tax rate as follows:

 

 

The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset (liability) were as follows:

 

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

Based on the level of historical taxable income and projections of future taxable income over the periods in which the deferred tax assets are deductible, management believes that it is more likely than not that the Company will not realize the benefits of these deductible differences. Accordingly, the Company has recorded a valuation allowance against its net deferred tax assets, excluding the indefinite-lived goodwill deferred tax liabilities as of December 31, 2016 and 2015. The Company’s valuation allowance increased by $9.6 million and $5.7 million in 2016 and 2015, respectively, due to the increase in total deferred tax assets.

As of December 31, 2016 and 2015, the Company had federal tax net operating loss carryforwards of approximately $138.5 million and $116.4 million, respectively, which will be available to offset earnings during the carryforward period. If not used, these carryforwards begin to expire in 2026. The Company’s research and development credit carryforwards, if not used, begin to expire in 2026.

At December 31, 2016, there were $1.6 million of unrecognized deferred tax assets that arose from tax deductions for equity compensation in excess of compensation recognized for financial reporting during years when net operating losses were created. Since the Company has adopted ASU 2016-09 effective January 1, 2017, these deferred tax assets will become recognized but will be subject to a full valuation allowance.  As such, there will be no net impact on the financial statements from this adoption.

At December 31, 2016 and 2015 the total unrecognized tax benefit was zero. The Company does not believe that its unrecognized tax benefits will significantly change within the next 12 months.

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The Company’s 2006 to 2016 tax years remain open and subject to examination by the United States. The Company remains subject to possible examination in various other jurisdictions that are not expected to result in material tax adjustments.

NOTE K – EARNINGS PER SHARE

Basic net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. Because the Company has reported a net loss for all periods presented, diluted net loss per share is the same as basic net loss per share for those periods as all potentially dilutive shares consisting of convertible preferred stock, restricted stock units, stock options and warrants were antidilutive in those periods.

The following table sets forth the computation of the Company’s net loss per share:

 

The following potentially dilutive securities outstanding have been excluded from the computations of diluted weighted average shares outstanding because such securities have an antidilutive impact due to losses reported:

 

 

NOTE L – COMMITMENTS AND CONTINGENCIES

License Agreement with Acclarent, Inc.

In February 2011, the Company entered into a license agreement with Acclarent, Inc. (“Acclarent”) in connection with the settlement of then-ongoing litigation in which Acclarent alleged that the Company’s FinESS and XprESS products infringed certain claims of five of their patents, which allegations the Company denied. In October 2012, the Company agreed with Acclarent to amend certain terms of the license agreement (as amended, the “Acclarent License”). Pursuant to the Acclarent License, Acclarent granted the Company a worldwide, non-exclusive, royalty-bearing license under certain patents held by Acclarent to manufacture, use and commercialize the Company’s currently marketed XprESS, PathAssist and FinESS products and certain future versions of those products (collectively, the “Covered Products”) in the field of the expansion of paranasal sinuses and sinus pathways.

Under the Acclarent License, the Company made an initial up-front, lump-sum payment to Acclarent as a retroactive royalty payment. The Company is also required to pay Acclarent an ongoing royalty in the low double-digit percentages, on a country-by-country basis, on net sales of Covered Products. Royalty expense is included in the costs of goods sold and is recognized in the period when revenue is recognized on Covered Products. The Acclarent License will expire upon the expiration or abandonment of the last to expire of the patents licensed to us under the agreement. Acclarent has the right to terminate the agreement upon 60 days’ notice in the event of the Company’s uncured material breach. Amounts due for royalties payable are recorded within accrued expenses on the consolidated balance sheets.

Operating Leases

As of December 31, 2016, the Company has three leased facilities under operating lease agreements. The Company entered into a 41-month lease in February 2012, effective April 1, 2012, for its manufacturing facility and corporate headquarters. The Company entered into a 50-month lease on June 30, 2014, effective July 1, 2014, for additional distribution space in a second facility. On February 26, 2015, the Company exercised its right to extend the lease term of its manufacturing facility and corporate headquarters for an additional three years through August 2018. On June 30, 2015, the Company entered into amendments to each lease agreement, among other things, to expand the space occupied by the Company at the property at which the Company’s corporate headquarters are located, and to extend the term of each lease agreement through June 2021, with an option to extend each lease for an additional term

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through June 2024. Rental payments on operating leases are charged to expense on a straight-line basis over the period of the lease. These lease agreements require the Company to pay executory costs such as real estate taxes, insurance and repairs, and includes renewal and escalation clauses. In connection with the XeroGel acquisition, the Company assumed a lease agreement for manufacturing facility space in Hayward, California through August 31, 2017. Rental payments on operating leases are charged to expense on a straight-line basis over the period of the lease. This lease agreement requires the Company to pay executory costs such, as real estate taxes, insurance and repairs, and includes renewal and escalation clauses.

Approximate minimum future obligations which include monthly contractual lease payments under operating leases with initial terms in excess of one year are as follows:

 

(in thousands)

 

Total lease expense was approximately $0.6 million, $0.3 million and $0.3 million for the years ended December 31, 2016, 2015 and 2014, respectively.

Other Commitments

In June 2016, the Company entered into an Amended and Restated Fiagon NA Distribution Agreement with Fiagon NA Corporation in which the Company was granted exclusive distribution rights in the United States and Canada for Fiagon Image Guidance Systems and certain components, parts and related ancillary products i) to hospitals, ii) to ENT physicians in the office, clinic, and surgery centers, and iii) under ENT healthcare system contracts. The terms of the Fiagon Distribution Agreement require the Company to purchase minimum quantities of Fiagon IGS and certain other disposable products through August 9, 2020 in order for the Company to retain exclusive distribution rights.

NOTE M – EMPLOYEE BENEFIT PLAN

The Company maintains a tax-qualified 401(k) retirement plan (“401(k) Plan”) for its U.S. employees. Eligible employees may make pre-tax 401(k) contributions under the 401(k) Plan, up to Internal Revenue Code limits. In addition, the Company, in its sole discretion, may make annual matching contributions and/or non-elective employer contributions to the 401(k) Plan. No such discretionary non-elective employer contributions were made during the years ended December 31, 2016, 2015 and 2014 and no such discretionary matching contributions were made during the years ended December 31, 2015 and 2014. During 2016, the Company has accrued for matching contributions that the Company may, in its discretion, make to the 401(k) Plan for the 2016 plan year (ending December 31, 2016) with accruals generally based on a matching contribution for each eligible employee that would be the lesser of: (1) 50% of the eligible employee's 2016 pre-tax 401(k) contributions and (2) 50% of up to 6% the eligible employee's 2016 eligible compensation.  The Company’s matching contribution expense during the year ended December 31, 2016 was $0.5 million and zero during the years ended December 31, 2015 and 2014. The Company’s non-elective employer contribution expense was zero during the years ended December 31, 2016, 2015 and 2014. The Company also provides retirement benefits for Entellus Medical Europe, Ltd., employees. Total contributions to retirement plans for Entellus Medical Europe employees were less than $0.1 million in 2016 and in 2015 and zero in 2014.      

NOTE N – SEGMENT AND GEOGRAPHICAL DATA

Operating segments are defined as components of an enterprise for which separate discrete financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company globally manages the business within one reporting segment. Segment information is consistent with how management reviews the business, makes investing and resource allocation decisions and assesses operating performance. Products are sold principally in the United States.

The following table represents total revenue by geographic area, based on the location of the customer:

 

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All of the Company’s long-lived assets are located in the United States.

NOTE O – SUBSEQUENT EVENT

In the first quarter of 2017, the Company completed a public offering of shares of its common stock, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain existing stockholders of the Company also sold approximately 1.2 million shares of common stock in the offering. The Company received estimated net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions and offering expenses payable by the Company. The Company did not receive any proceeds from the sale of shares by the existing selling stockholders.

NOTE P – QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the Company’s unaudited quarterly results of operations for the years December 31, 2016 and 2015:

 

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SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

 

 

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None.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated, as of the end of the period covered by this Annual Report on Form 10-K, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act). Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2016.

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting, as defined in Rules 13a-15(f) al 15d-15(f) under the Exchange Act, that occurred during the quarter ended December 31, 2016 that has materially affected, or is reasonably likely to material affect, our internal control over financial reporting.

Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.

Our management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in “Internal Control-Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that, as of December 31, 2016, our internal control over financial reporting was effective.

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm on internal control over financial reporting due to an exemption established by the JOBS Act for “emerging growth companies”.

Entellus Medical, Inc. 2017 Bonus Plan

On February 16, 2017, our compensation committee and board of directors approved an Entellus Medical, Inc. 2017 Bonus Plan, which serves as our annual short-term cash incentive plan. Robert S. White, our President and Chief Executive Officer, and Brent A. Moen, our Chief Financial Officer, among other executive officers, are eligible to participate in the 2017 Bonus Plan. The 2017 Bonus Plan ties their annual incentive awards closely to our performance.  

Under the 2017 Bonus Plan, the executive officers will be eligible to earn annual short-term incentive awards based on our achievement in 2017 of performance goals relating to (i) revenue growth (65% weighting); (ii) operating income (loss) (15% weighting); (iii) revenue growth from balloon sinus dilation product sales (5% weighting); (iv) clinical evidence (5% weighting); (v) education and efficiency (5% weighting), and (vi) quality (5% weighting). The actual amount of each executive officer’s bonus earned pursuant to the operating income (loss) criteria will be reduced by 50% if the actual expenses of such executive officer’s department exceed the budgeted plan.

Under the 2017 Bonus Plan, Messrs. White and Moen are eligible to receive the following threshold, target and maximum awards:

 

 

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Each executive officer must be employed by our company through the date on which we pay and/or grant annual incentive awards under the 2017 Bonus Plan in order to be eligible to receive an annual incentive award under the plan.

Entellus Medical, Inc. Officer Severance Plan

On February 16, 2017, our compensation committee approved the Entellus Medical, Inc. Officer Severance Plan. The purpose of the Officer Severance Plan is to replace our existing practice of entering into an individual severance agreement with each new officer. Subject to certain exclusions, the Officer Severance Plan would cover all executive officers of the Company (other than the Chief Executive Officer who would have an individual agreement) and only those non-executive officers of the Company as determined in the discretion of the Chief Executive Officer. In addition to the express exclusion of the Chief Executive Officer, the Officer Severance Plan provides that any officer who has rights to severance under any individual agreement or other plan or policy will not be eligible to receive benefits under the Officer Severance Plan. Therefore, our current officers who have rights to severance under any individual agreement or other plan or policy will not be eligible to receive benefits under the Officer Severance Plan.

The severance benefits provided under the Officer Severance Plan are substantially the same as the terms set forth in our existing officers’ individual severance agreements and consist of two components: severance pay and COBRA reimbursements. The entitlement to severance benefits under the Officer Severance Plan would arise only in the event of an involuntary termination of employment (by us other than for cause, death or disability or by the officer for good reason). The amount of severance pay would be 12, six or three months’ of base pay, depending on the officer’s level (executive or non-executive) and whether the officer’s termination is in connection with a change in control. If a termination occurs in connection with a change in control, then the severance pay amount would be two times the officer’s non-change in control severance  pay amount, plus 100% (or for non-executive officers, 50%) of the officer’s target bonus for the year of termination. For example, if an executive officer receives six months base pay for regular severance, then the officer would receive 12 months base pay for a change in control severance, plus 100% of his or her target bonus for the year of termination. In addition, if the officer is eligible for and timely elects COBRA continuation coverage under the Company’s group medical and/or dental plans, for a specified premium reimbursement period the officer  will be reimbursed for an amount equal to the difference between the amount the officer paid for COBRA coverage and the amount paid by a full-time active Company employee for the same level of coverage elected by such officer plus the amount, if any, the Company would have contributed to a health savings account (or other arrangement), had the officer been employed by the Company during such time period. The premium reimbursement period corresponds to the number of months of base pay used to calculate the officer’s severance pay, but will end earlier if the officer is no longer eligible for COBRA continuation coverage or the officer becomes eligible to participate in another group medical plan or group dental plan, as the case may be, because of reemployment or otherwise, whether or not the officer elects to participate in such plan. The Officer Severance Plan also provides for automatic acceleration of vesting of equity awards upon an involuntary termination after a change in control and all stock options held by the officer would remain exercisable for one year after the termination date, but in no event after the expiration date of any stock option. All severance pay and benefits would be conditioned upon receipt of a release of claims from the officer.

A copy of the Officer Severance Plan is attached to this Annual Report on Form 10-K as Exhibit 10.30 and is incorporated herein by reference. The above description of the Officer Severance Plan is not intended to be complete and is qualified in its entirety by the specific language in the Officer Severance Plan.

Amendment to Change in Control Severance Agreement

On February 16, 2017, we and Robert S. White, our President and Chief Executive Officer, entered into an amendment to Mr. White’s existing Change in Control Severance Agreement pursuant to which we agreed to increase his severance pay upon a termination of his employment in connection with a change in control from (a) 12 months base pay plus 100% of his target bonus to (b) 24 months base pay plus 200% of his target bonus.  We also agreed to increase the maximum length of time that he may receive reimbursement of a portion of his monthly COBRA continuation coverage premiums, if he is eligible for and timely elects such coverage, from 12 months to 18 months (or, if earlier, until he becomes eligible for group health and dental benefits for himself and his dependents with his subsequent employer).

A copy of the amendment is attached to this Annual Report on Form 10-K as Exhibit 10.32 and is incorporated herein by reference. The above description of the amendment is not intended to be complete and is qualified in its entirety by the specific language in the amendment.

Resignation of Named Executive Officer

On February 16, 2017, Jeff Kogl, our Vice President, Business Development & Strategy, resigned effective as of February 21, 2017 to pursue other opportunities.  

 

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PART III

The information required by this Item is incorporated by reference to information to be contained under the headings “Executive Officers” and “Corporate Governance” in our definitive proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2016.

Material Changes to Procedures by Which Stockholders May Recommend Board Nominees

We did not make any material changes to the procedures by which stockholders may recommend nominees to our board of directors, as described in our proxy statement for our 2016 Annual Meeting of Stockholders, during the three months ended December 31, 2016.

Code of Business Conduct and Ethics

Our board of directors has adopted a code of business conduct and ethics applicable to all officers, directors and employees, which is available under the Corporate Governance section of our website at www.entellusmedical.com. We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding amendment to, or waiver from, a provision of our code of business conduct and ethics, as well as the requirement by the NASDAQ Listing Rules to disclose waivers with respect to directors and executive officers, by posting such information on our website at the address and location specified above.

The information required by this Item is incorporated by reference to information to be contained under the headings “Executive Compensation” and “Director Compensation” in our definitive proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2016.

The information required by this Item is incorporated by reference to information to be contained under the heading “Stock Ownership” in our definitive proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2016.

Equity Compensation Plan Information

The following table provides information as of December 31, 2016 regarding compensation plans under which our equity securities are authorized for issuance.

 

 

The 2015 Plan was adopted by our board of directors in connection with the closing of our initial public offering in 2015, and provides for awards of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, dividend equivalents, restricted stock units, performance awards, performance share awards, stock payment awards and other incentive awards to be available for employees and consultants of our Company and any of its qualifying subsidiaries and for our directors.

The number of securities available for issuance under the 2015 Plan increases annually in an amount equal to the lesser of (A) 875,000 shares of common stock, (B) 4% of the shares outstanding (on an as converted basis) on the last day of the immediately preceding fiscal year, assuming the conversion of any shares of preferred stock, but excluding shares issuable upon the exercise or payment of stock options, warrants and other equity securities with respect to which shares have not actually been issued and (C) such smaller number of shares as determined by our board of directors.

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The number of securities available for issuance under the 2015 Employee Stock Purchase Plan increases annually in an amount equal to the lesser of (A) 1% of the shares of common stock outstanding on the date of adoption of the 2015 Employee Stock Purchase Plan and (ii) such smaller number of shares as determined by our board of directors.

We are no longer permitted to grant awards under the 2006 Plan.

The information required by this Item is incorporated by reference to information to be contained under the headings “Certain Transactions with Related Persons” and “Corporate Governance—Director Independence” in our definitive proxy statement for our 2017 annual meeting of stockholders to be filed with the SEC within 120 days of December 31, 2016.

The information required by this Item is incorporated by reference to information to be contained under the headings “Proposal No. 2. Ratification of Appointment of Independent Registered Public Accounting Firm—Audit, Audit-Related, Tax and All Other Fees” and “Proposal No. 2. Ratification of Appointment of Independent Registered Public Accounting Firm—Pre-Approval Policies and Procedures” in our definitive proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2016.

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PART IV

The financial statements required by this item are listed in Item 8, “Consolidated Financial Statements and Supplementary Data” herein.

The financial statement schedule required by this item is listed in Item 8, “Consolidated Financial Statements and Supplementary Data” herein.

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: February 22, 2017

KNOWN BY ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert S. White and Brent A. Moen, or either of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and any documents related to this report and filed pursuant to the Securities Exchange Act of 1934, as amended, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes may lawfully do or cause to be done by virtue hereof. This power of attorney shall be governed by and construed with the laws of the State of Delaware and applicable federal securities laws.

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

 

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